Proceedings of the Standing Senate Committee on
Banking, Trade and
Commerce
Issue 26 - Evidence - Morning sitting
OTTAWA, Monday, September 28, 1998
The Standing Senate Committee on Banking, Trade and Commerce met this day at 10:10 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.
[English]
The Chairman: Senators, I call the meeting to order.
Welcome to our opening session of two months of hearings on the Task Force on the Future of the Canadian Financial Services Sector, otherwise known as the "MacKay Task Force" after its chairman, Harold MacKay, which means, of course, that if people end up liking what the task force does, lots of people will share the credit, but if people end up not liking what it does, the chairman will get the blame. That is a feature of public life.
For the record, I will outline the committee's proposed agenda. We will start with two weeks of hearings in Ottawa and then spend three weeks on the road. Then we will hold another week of hearings back in Ottawa before we submit our final report. We have agreed we will report to the government on or about December 1.
All of the hearings will be televised by CPAC.
Today, our opening day, the chairman, the executive director, the vice-chairman, and the director of research of the task force will have an opportunity to take us through their report so we have not only a comprehensive understanding of the report from having read it, but also have the opportunity to understand the thinking behind the various recommendations in the report. Accordingly, we will have a three-hour session this morning, a hour's break for lunch, and then as much time this afternoon as we need in order to get the information we want.
I have asked the chairman to begin with a relatively brief opening statement. We will try to go through the report and its key recommendations in a sequential fashion, focusing on chapter 6, which is the competition and competitiveness chapter, and chapter 9, which is the regulatory framework chapter. Then we will deal with the consumer issues. That is to say, we will deal with the two business-driven chapters first, and then with the two consumer chapters.
I thank all of you for taking the time to be with us today. I would ask Mr. MacKay to begin with his opening statement but perhaps first, for purposes of both the television audience and, equally important, our Hansard reporters, would you introduce your colleagues at the table so that both the audience and the reporters know who is speaking when they are responding to a particular question?.
Mr. Harold MacKay, Chairman, Task Force on the Future of the Canadian Financial Services Sector: Thank you very much, Mr. Chairman. We are pleased to be here with you this morning. My colleagues are: Pierre Ducros, vice-chair of task force; Fred Gorbet, our executive director; and Michael Andrews, the associate research director of the task force. We propose that one chair be a kind of "musical chair" where you will see different faces, depending upon the topic being discussed.
Sitting somewhere in the audience are John Chant, the research director of the task force, and Louise Pelly, our senior researcher. Joining us later will be Kevin Wright, another research staff member.
Mr. Chairman, I would now proceed with the opening statement.
It is two weeks since our report was released. I must say we are gratified by the interest that has been shown in it across the country and at the reception the report has received. As you will know from having looked at it, it is a serious report that covers a wide range of territory.
Over that two-week period, Mr. Ducros and I have been speaking to groups of people across the country about the report. In doing so, we have had two objectives. The first has been to explain our conclusions and recommendations. The second has been to urge Canadians to participate in the discussion and debate, of which the work of your committee is a significant part.
I have told those to whom I have spoken that we must keep this dialogue and process moving forward. We have to do so recognizing that change is all about us.
We need to reconsider the issues here in the light of new circumstances and to consider old issues in new ways. As task force members, we must recognize that the challenges of change are significant. We must set aside romantic notions of the "good old days" and consider these issues from the perspective of the broad national interest. In an environment in which there are very often turf wars, special-interest thinking simply will not do.
Our task force wrestled with that age-old question: What is the public interest? After an internal brain-storming exercise, we defined it as best we could in the report by setting out our vision of what a financial services sector would look like that would best serve Canadians into the next century.
The vision is described in detail in the task force report. It emphasizes competition for consumers in a marketplace that operates fairly and responsibly in their interest. It emphasizes that you start with consumers and then work to the institutions, that there should be an open and competitive marketplace on the institutional side, and a flexible regulatory structure.
I wish to emphasize that our vision starts and ends with the consumer. It is focused on expanding choice, improving service and protecting rights.
We considered some technical issues, many of which we will discuss with you today, such as ownership principles, holding conditions, business powers, and foreign regulatory reform. Too often in past debates, these issues have been considered from the point of view of the industry participants, an approach that considers the question of who wins and who loses. We have tried our best to consider all these issues from the point of view of the Canadians who rely on financial services. The hopes and dreams of Canadians -- their ability to start businesses, to buy homes and to deal effectively and plan effectively for their retirement -- depend upon an excellent financial services sector. As we developed our recommendations for a competitive, dynamic and healthy sector, we constantly asked ourselves whether a particular change would make consumers better off or worse off.
I should also emphasize that the "who wins, who loses" approach is one we expressly rejected. Rather, our focus was on, and continues to be on, developing a responsible, realistic, forward-looking set of recommendations that create a win-win opportunity both for consumers of financial services and for the country.
As you go through your hearings, I hope you will keep this perspective in mind and challenge those who come before you to provide their vision of the public interest rather than just their special interest and to show how their proposals will benefit Canadian consumers.
The task force was persuaded, after our review, that Canada has a strong financial services system. It is a source of national strength and we should be proud of it. We believe, however, that while it serves most Canadians quite well today, there is room for improvement. We will have to work hard to ensure that it stays strong and that it serves Canadians even better.
Our report sets out a framework that will improve the performance of the sector. A hallmark of this framework is flexibility. We have been motivated in proposing a flexible regime by the realization that, in a turbulent world where crystal ball gazing can be fun but not productive, it would be a serious mistake to lock ourselves into regulatory structures that do not give our institutions and our regulators the capacity to adjust.
A key thrust of our recommendations is to promote an open and competitive marketplace by empowering consumers, by strengthening second-tier institutions, and by encouraging new entrants, both domestic and foreign. Canadians have every right to expect a wide choice of products and the best prices. A lot needs to be done. We have recommendations that will make it easier to start new banks and will encourage more competition in Canada from foreign banks and from life insurance companies. We also have recommendations to ensure that our credit unions and caisse populaires become strong players. We must ensure that Canadian public policy supports competition and does not stifle it.
We also want a marketplace that is more responsive and responsible. We want to be sure that consumers can enhance competition by bringing discipline to the marketplace. We want to be sure that they are treated fairly. There are new issues to resolve -- for example, the protection of privacy of information in an age of data mining, the prevention of coercive tied-selling at a time of super markets selling many types of financial products, and the need for effective and accessible redress mechanisms for consumers who have been treated unfairly. Our recommendations make concrete proposals on these matters. These recommendations will make the marketplace more responsive.
Quite legitimately, Canadians expect banks and insurance companies to be accountable to the communities they serve. Being in the financial services business is a privilege, not a right, and with that privilege come business responsibilities and social responsibilities.
The task force believes that our financial system will work best when it has the full confidence of Canadians. We make a number of recommendations about corporate conduct that will contribute to building stronger bridges between institutions and communities. They will make the marketplace more responsible.
As competition intensifies because of technology, and in response to our recommendations, we hope, our existing institutions will need to focus on new strategies if they are to continue to thrive and to serve Canadians well.
A great deal of attention has been focused on our recommendations with respect to mergers, particularly in the context of these two specific transactions that are now under consideration in Canada. We have said in our report that mergers can be a valid business strategy, but they are only one strategy among many. We have recommended a process to assess significant mergers to assure they are in the public interest. However, we have also recommended measures that we believe will increase the range of alternative strategies available to our institutions.
For example, we have recommended a new ownership policy for financial institutions that continues to capture the benefits of wide ownership for our largest institutions while allowing them flexibility to enter into strategic alliances or to make acquisitions that would result in shareholdings of up to 20 per cent and, in some cases, in excess of 20 per cent under very specific terms and conditions. We have also recommended changes to accounting principles that will put our institutions on more even ground with U.S. and other foreign institutions in considering business combinations.
We are proposing a "regulated holding company" option that will provide important organizational flexibility. The "holding company" proposal will provide a vehicle for medium-sized companies to come together in a financial conglomerate under common ownership, giving them the benefits of economy of scale and synergy without their losing their individual identity. It will also enable large institutions to explore with OSFI the possibilities of a more "nuanced" regulatory environment for certain functions that are not core to the business of taking deposits or selling insurance to Canadians.
Finally, we recommend that business powers be broadened. We see benefits to consumers from allowing more competition for transaction balances, and we believe that insurance companies, money market mutual funds and securities dealers should be able to participate directly in the payment system without much risk to the efficient functioning of the system. As you can appreciate, such a change would bring tremendous new sources of competition to what we call basic banking.
As well, we propose that, with proper regimes in place to protect privacy and prevent coercive tied-selling, the deposit-taking institutions should be allowed to retail insurance and both deposit-taking institutions and life insurance companies should be allowed to lease automobiles. These measures will provide additional options and flexibility to our institutions as they seek to adjust to a more competitive environment. It is essential that they succeed -- not just for the sake of maintaining strong institutions but because strong institutions that can compete with the best in the world will benefit Canadian consumers.
We believe that our recommendations will help to build a world-class financial system in Canada -- a system consisting of healthy institutions, most of which are Canadian-controlled; some of those institutions will focus on particular regions or business niches while others will be world-class competitors that are successful internationally. We want a world-class system to benefit Canadian users, whether they are looking for credit in rural Canada, exporting to Europe or opening a business in Latin America.
A vibrant, dynamic Canadian-controlled industry with major players, active in competitive world markets, provides benefits at home by importing best practices from abroad and by creating domestic activity that includes high quality employment that can keep our young people in Canada.
As we considered employment issues, it seemed to us that the most important contribution that the financial sector can make to employment is to be strong, competitive and innovative. If it is, and if it serves its customers well by providing the financing they need in an efficient manner, it will be an engine of economic growth and job creation not only in the sector but also throughout the whole economy.
We are suggesting that Canadians should stand back from their special interests and their own prejudices about banks and other financial institutions and take a look at Russia and Japan, where weak banking systems are destroying their economies and the savings of individuals. We would like to see strong institutions in Canada -- not to assist the companies but for the good of the Canadians they serve. A healthy, profitable financial services sector will help to ensure a strong, healthy and competitive Canada. We would urge Canadians to be open-minded and take pride in building a world-class financial services system. For our part, the task force is confident that we can do that.
Mr. Chairman, thank you for the privilege of appearing before you to make this statement. We look forward to the discussion today. I have invited my colleagues to participate fully in that discussion so that we can have the most informed dialogue possible with you.
The Chairman: Thank you, Mr. MacKay. You have touched on a lot of the topics in the report. In particular, you touched on almost all the major sub-topics in chapter 6, which is where we wanted to begin. Are there any other additional comments that you want to make on chapter 6?
Perhaps my colleagues would want to take chapter 6, of which the first major sub-topic is ownership rules, and discuss the topics sequentially so that all the questions on ownership can be dealt with at one time. Or would you prefer to consider the whole chapter as an integrated unit? Which do you think would be most helpful?
Mr. MacKay: It might be best if we broke it into pieces. I am prepared to provide a brief, focused statement, on ownership or business powers, that would be more intensive than the overview comments I have just made.
The Chairman: Let us begin then with the ownership material that begins on page 81 of the summary document and goes through to page 88. Mr. MacKay will comment.
Mr. MacKay: Standing back from it, when we looked at the present ownership rules we were struck by the fact that different ownership rules apply to different kinds of financial institutions. At the end of the day, in an era of convergence of function and the building of financial conglomerates, we thought that that should be changed; that there should be a consistent set of ownership rules across the spectrum.
Having decided that, we asked ourselves: What should be the goals of ownership rules? They certainly should not inhibit competition.
We tried to stand back from ownership rules. We are of the view that we need an ownership policy that will sponsor competition, sponsor alliances, maintain a safe and sound financial system and maintain Canadian ownership of most of that system.
With those goals in mind, we looked at the present rules and decided that there were rigidities, particularly in the bank rule, with its requirement of 10 per cent, regardless of the size of the institution. We have proposed, in effect, that for smaller institutions, closely held financial services companies should be permitted. By "small," we have suggested that that would mean institutions with less than $1 billion worth of shareholders' equity. For the largest institutions, those with more than $5 billion worth of shareholders' equity, we propose that there should be a widely held rule to obtain safety and soundness in Canadian-controlled benefits. However, we would proposed a more flexible, widely held rule that would, under guidelines to be issued, permit shareholdings of up to 20 per cent in circumstances that would enhance competitiveness or competition or facilitate the strengthening of the system or institutions. We can attain the goals we seek with greater flexibility in the system, which would facilitate alliances and acquisitions.
The middle zone, between the $1 billion and $5 billion, would be governed by a set of principles that are similar to those presently in existence for trust companies and insurance companies.
Mr. Chairman, working out from that, we have also made a number of suggestions relating to demutualized life insurance companies, the present smaller institutions and a number of other important matters that I expect will come up in questioning.
Our thrust was to get a consistent set of rules, one that will provide more competition in the marketplace and, at the same time, will maintain the goals for large institutions -- systemic stability and a Canadian-based industry.
Senator Tkachuk: Mr. MacKay, as you know, the process of changing our financial institutions began under the previous government with the collapse of the independent pillars of the financial structures. This allowed banks to become involved in the investment industry and the consolidation of trust ownership.
I have some general questions before we get into the specifics of the ownership policy. This has more to do with what banks have become. People put money in banks because they have an innate understanding of what the banks will do with that money. They will lend it to their friends and neighbours in the community, and they know how this works because they themselves borrow money.
However, we have allowed the financial service industry to convince us that somehow, by integrating products, banks become safer. Only the entertainment industry has been able to convince people that amalgamation makes things better. Has the purchase of the investment companies, the brokerage firms, by the banks made those firms safer and sounder?
Mr. MacKay: If you were to reach back in history, you will find that, at least with the trust company industry, there was an issue of partly rescuing that industry. There was a safety-and-soundness consideration on the other side of that particular piece of conveyance.
Senator Tkachuk: The banks rescued the trusts.
Mr. MacKay: If you were to stand back and ask if these institutions have become safer and sounder because they have been doing more things, it would be hard to make that case. Have they become so risky that they are incapable of effective regulation? It is also hard to make that case.
There is no doubt in our view that the nature of banks has changed dramatically, as your question implies. Banks already are not recognizable from what they were 40 years ago. This is not only Canada; the same is true around the entire world, as banks have subsumed many new responsibilities. Many of the recommendations we have made will complete the process you have described of permitting as many competent institutions as possible to engage in different business functions. We think that that will not erode the safety and soundness of those institutions.
Senator Tkachuk: My concern arose when we were studying the SBLA, the Small Business Loans Act. We were in Alberta and British Columbia and small businesses expressed extreme negativity about the services they get from banks.
We allow certain institutions to take deposits. It is a great public trust to take people's money, and we have developed an insurance system around that. By allowing integration into these many other businesses, banks, rather than lending money -- which is why we allow them to take money -- will try to find other businesses, where they think there are greater rewards for their shareholders, to use that money.
Do you see that as a coming problem? Small business sees that as a problem. They do not believe they are getting good service. The Bank of Montreal even says that if they are allowed to amalgamate, they will set up a bank for small business. That sounds like they are admitting their failure. There is a problem here.
Mr. MacKay: We have had a look at things like turn-down rates in Canada and the United States. We have actually found that they are about the same. However, we have found that there is not a good relationship with the Canadian small business community. It is not a good relationship. In one of the chapters of our report, we have described the fraying of the relationship.
In our own view, it does not relate to denial of access to credit except at high-risk levels, but we have identified the fact that the Canadian banking system, for whatever reason, seems to cap out the price at which it will lend at prime plus 2 per cent or 3 per cent.
If you are a customer with a risk profile that exceeds that, it appears, perhaps for public relations or communities profile reasons, that the Canadian banking system will simply deny you the credit, whereas the American banking system will extend you the credit with a more innovative financing package, including some significantly higher pricing.
When you stand back from it all, we have discovered that, in Canada, the margins charged are actually lower to small business customers than they are in the United States. The turn-down rates are about the same. The relationship, however, in terms of how the American business community views the small business service is quite different. They appear not to have the same tension in the air when they talk about banks. We have come down on the side of saying the real issue is service, which you mentioned in your remarks, senator, not especially availability. We have also suggested that Canadian banks should be prepared to look at their pricing policies so as to be more ready to assume more risk at a higher price -- priced appropriately for risk.
We did not find evidence of the diversion of deposits away from small business to other activities. That was not a conclusion we reached in our work.
Senator Tkachuk: On page 81, the report says:
We considered the issue of wide ownership and we concluded that the objectives served by wide ownership -- Canadian control and the separation of finance and commerce -- continue to be valid objectives.
What do you mean by "the separation of finance and commerce"?
Mr. MacKay: We are talking about whether or not commercial interests can own a bank or other financial institution -- a commercial interest that might, for instance, be in another line of business, a retailer, a supermarket, an information-technology company. The separation of commerce and finance is achieved by the widely held rule by simply and somewhat bluntly saying that no one commercial institution can own more than, in the case of the Canadian rule, 10 per cent of a bank.
Senator Tkachuk: Does that mean we are hesitant to allow Canadian Tire to become a bank but not necessarily hesitant to allow a bank to own Canadian Tire?
Mr. MacKay: There are also restrictions on a bank owning Canadian Tire. The ability to equity invest in Canadian Tire is governed by a strict set of rules related to the so-called "specialized" financing corporations. Banks can set them up and dedicate a portion of their capital to equity investments, but there are strict limits on the amount of capital dedicated to that purpose and on the amount of any individual investment. There are downstream restrictions on banks in terms of investing in companies such as Canadian Tire.
Upstream, under our ownership rules Canadian Tire should be able to own a bank, so we have changed the rule. We would permit Canadian Tire to own its own bank rather than it having an alliance with a bank to put a financial kiosk in its stores, as is the present rule and as is the present intent, as long as that bank did not become of such a size that it would require to provide depositor protection or deal with other governance issues which would move it into the widely held zone. If the Canadian Tire bank in our system came to have more than $5 billion worth of equity, we would require it to be widely held because we believe its failure could raise safety and soundness issues for the financial system as a whole, something which a small Canadian Tire bank would not do.
Senator Tkachuk: How did the members of the task force resolve the difference between a brokerage firm and Canadian Tire? What is the difference?
Mr. MacKay: One is a financial service. The products offered by the brokerage firm are, in fact, viewed as a financial service not only in Canada but also around the world. That is a financial services business. The law here and our recommendations would continue to permit a financial supermarket, as the law does in most countries, although it is still evolving in countries such as the United States, as you know, in that direction. That is the difference.
Senator Tkachuk: In your report, you recommend leasing, and you see leasing as a financial service, but is it?
Mr. MacKay: When it is a product that is being offered in lieu of a loan, it is a financial service. For instance, if you look at that particular marketplace, you will see that the leasing of cars has expanded from 4 per cent of the car acquisition market to some 47 per cent over a six-year or seven-year period, and loans have shown a commensurate decline. From that it is evident that the leasing of a small vehicle is an alternate financing technique to the lending which had gone on for years before. In all other countries that we studied, it is viewed as a financial service. In Canada, it is viewed as a financial service, but there is a restriction on the leasing of light vehicles, not of other properties.
Senator Tkachuk: When they lease cars, the banks actually buy the cars. They own the cars. The person who leases the car does not own it. In other words, they have not been competitive in packaging loans in such a way that consumers can own cars rather than lease cars. Now they are crying because they are losing a big part of the business because the car industry has made it more attractive to lease than to borrow money to buy a car. Because they have failed in being more competitive and offering a good financial service to make it more attractive for people to own cars rather than lease them, people now want to lease cars which, in reality, puts the banks in the car business because they now own the leased cars. After two or three or four years of leasing, they find themselves in the used car market because they must dispose of the car at the end of the lease.
Mr. MacKay: They are no more in the used car business than they are in the used Caterpillar or heavy equipment business. They are in the business of leasing other kinds of property. The only thing that financial institutions in Canada -- and this is unique as far as we can find out in the Western world -- are prevented from doing, is leasing light vehicles. They are not in the used car business. In practice, in other countries, they enter into relationships with people who are in the business of disposing of the used cars.
Our Bank Act, as you know, would prevent, in the case of any lease, a bank referring a customer to a particular dealer. It is designed to have the bank provide the financial product and not the merchandise itself. It is true that, technically, the financial institution owns the vehicle. That is the only way you can do a lease.
In our version of the leasing world, we are not urging consumers to stampede off to banks, credit unions, or other financial institutions to do leasing. We are saying that there ought to be a choice to go to those institution as there is elsewhere, including Quebec with the caisses populaires, which already lease vehicles. We are suggesting that that will provide competition to the very large manufacturers who currently enjoy about 80 per cent of the market in Canada but only 50 per cent in the United States. It is another competitive alternative for consumers, nothing more or less.
Senator Tkachuk: Will they use deposit money and for leases?
Mr. MacKay: They will use it to lease vehicles.
Senator Tkachuk: They, therefore, will have a competitive advantage over leasing companies that must go to capital markets or borrow money from banks or find some other way to raise capital. Banks have my money on deposit, pay me 3 per cent in interest, and apply it to a lease at 6.8 per cent.
Mr. Michael Andrews, Associate Research Director, Task Force on the Future of the Canadian Financial Services Sector: I have a comment on the cost-of-funds argument. It is not at all clear that, when you factor in the costs of running a branch network, for instance, that the cost of funds raised through deposit-taking is less than the cost of funds that may be raised in the wholesale market by companies engaged in leasing. We certainly heard submissions on both sides of that argument. Non-financial institutions tend to argue that the financial institutions have the cost-of-funds advantage. The financial institutions suggest the alternative. We were unable to determine, conclusively, that either party had a particular advantage.
Senator Kolber: I have three broad questions and I am sure we will have the opportunity to discuss details in due course.
Your report makes the point that the Canadian banks have not adapted well to the changing financial landscape. Moreover, the report suggests that the banks do not have much time to make the substantial changes necessary. What would happen if the status quo persisted?
I understand that the Canadian financial industry is integral and important to this country. If nothing is done, the banks have said that they will become marginalized; that within 10 years the industry will be second-rate and will be dominated by foreigners. That may be too cataclysmic a prediction. I would be interested to hear your reaction.
Mr. MacKay: I am not certain we said that the banks have not adapted well.
Senator Kolber: You say there is little time to do things.
Mr. MacKay: That is a slightly different statement. There is the need to continue to adapt. There is the need to have a serious business strategy, and to pursue it. This is no time to think that old-time strategies will work over the medium term, because there are rapid changes taking place in the sector.
It is always interesting to look at the bigger picture, and we have done some of that in the report. For example, in the last six or seven years, mutual funds have risen about 600 per cent and personal deposits are somewhat flat. One can deduce that traditional sources of cheap financing for the banks has shifted into other competitive products. It is an interesting fact.
Consolidation around the world is evident to all of us as we read the newspapers. We wonder what it means and why it is happening. However, it is evident to the financial services industry that consolidation is a significant fact, a response to some of the change forces.
The banks' share of corporate lending in Canada has fallen in 10 years from 44 per cent to 34 per cent as especially large corporations have finally had access to capital markets and have by-passed the banks. Therefore, according to our information, the banks have a poor rate of return on their corporate loans whereas, 15 years ago, they had a very significant rate of return.
In individual product lines, banks, credit unions and others are being significantly challenged. No one knows what market share MBNA, Bank One and Capital One will take of the credit card market in Canada. In the United States, the same three companies have driven most banks out of the credit card market. However, there are some very successful exceptions to that.
When you stand back from all of that -- and there are many more facts and figures one could cite -- you have an industry in significant transition, challenged by the very technology which is so wonderful for both it and its customers.
After we wrote the report, I came upon a fascinating article in a business magazine that described competition going on in Hong Kong in the smart card business. There are two groups of people in Hong Kong who are issuing smart cards, one is the railway company, and the other is the Hong Kong and Shanghai Bank. Each is using quite different technologies. Hong Kong and Shanghai Bank is using the Mondex-type technology, as it is used in Canada, and the railway company is using an apparently superior Sony technology. The railway company is beating the pants off the Hong Kong and Shanghai Bank. Many people are asking if the railway company has become a bank and, if so, should they be regulated as a bank. That has led us to say, "Don't count on doing it the old way, you better look at doing it a new way."
Another statistic that occurs to me is that, in a few short years, the number of transactions performed in branches has fallen from some 38 per cent to 21 per cent. Transactions are being done in other ways. Branches are becoming places where you get advice, not places where you do transactions. This is an industry in unbelievable transition. It stands to reason, therefore, that doing things the old way will not be an option. There must be a strategy. This is not to say the banks must merge.
Senator Kolber: It also does not say you do not have to merge.
Mr. MacKay: That is right. We have said mergers can be one response to that changing world.
Senator Kolber: The report puts the case that the banks have not taken sufficient risks, particularly in the area of venture capital type investments. Has the task force considered Canada's industrial policy as a way of dealing with this issue?
Have changes to tax policy been considered? Do we have enough tax incentives in this country to induce people to take risks in venture capital type endeavours? I do not happen to think banks are the place where it should be done. For example, if someone wishes to take a risk and provide money for some great new idea and it happens to succeed, in our country, when that person sells, they are required to give 40 per cent to the government. In the United States the requirement is for 20 per cent. Has the task force addressed the question of taxation as a way of solving some of these risk-taking problems?
Mr. MacKay: The short answer is no. One of our consultants who examined venture capital financing type issues for us came to the bottom line that that is where public policy should look if it wanted to spur more financing in the venture capital area.
We have not exhorted the banks to be more active in providing funds in venture capital. We have said that they should continue the significant steps they have taken over the last five to six years and which are chronicled in the report. We found significant commitments of money since the laws were liberalized which have permitted the venture capital activity in which all of the banks are now participating.
Initially, we were somewhat jaundiced as to whether the banks were doing much more than authorizing money, and whether it was actually being committed. We would like to see continuing progress along those lines.
Senator Kolber: You do say "take more risk."
Mr. MacKay: In respect of venture capital?
Senator Kolber: No, in respect of the banking business.
Mr. MacKay: In respect of venture capital, we expressly recognized that banks are stewards of the deposits which they take. They have made progress down this road. We do not think there should be public policy initiatives to further push them to take more risks in venture capital.
We did not feel we had a mandate to go into the tax incentive business. We were a financial institution task force. Our consultant did suggest that is the answer, senator.
Senator Kolber: The history of closely held financial institutions has been a public policy disaster in Canada; two examples are Royal Trust and Central Trust. What is it in the business environment that now suggests that yet another experiment with closely held institutions would result in a different outcome?
Our experience with regional banks vis-à-vis national banks is also not particularly noteworthy. It is not obvious that small institutions or foreign institutions entering Canada through branches or subsidiaries will make the Canadian financial system more competitive, except maybe at the margin.
Can the task force point to any developed democracy other than New Zealand where offshore institutions have provided a measurable supplement to competition among indigenous institutions at the retail level?
Mr. MacKay: To give you an illustration of what is going on in the rest of the world, supermarkets in both the U.K. and Australia are delving directly into the banking business to provide retail banking services. We think that that is good, not bad.
During the course of our study, we reviewed some of the new institutions being formed in the United States. In the course of this consolidation period which they are experiencing, they are spawning many new institutions, many of them quite small.
We have had a look at the public-offering documents of new regional banks; in Seattle, for instance, we looked at two $10 million start-up regional banks, one of which had been in business for some years and appeared to be quite successful. The second was modelling its activities on that bank.
Can we demonstrate that there will be new full-range banking institutions with branches spread across the country as the only new entrants? We think super markets and others may provide some of that. We believe many of these new entrants will turn out to be single-product providers using new technology. There is no particular reason that in Canada we cannot spawn an MBNA. There is no reason we cannot spawn one country-wide; we are capable of that. We see this incentive <#0107> well, in fact it is not an incentive at all, but we think it would provide a massive new set of branches from coast to coast.
You have mentioned the problems that have existed in the past with closely held institutions, but at end of the day you must make a decision as to whether you wish to have an entrepreneurial culture or not. We think we have a regulatory system that will work.
It was interesting that the Estey report, which looked at a couple of the institutions that failed, expressly pointed to factors other than the fact that they had a regional base and that they were small. That was in another regulatory regime in which, in effect, the report indicated that the government had opened the gates but had not put a regulatory regime in place that would work. Mr. Estey expressly said that he did not wish to be taken as denying the validity of new entrants to the market.
The long and short of it is that, as you look around the world, some smaller institutions thrive and some fail, and essentially we have said that the risk of failure must be recognized. We think we have a superior regulatory system compared to what we had in the period you have described, but we fully recognize that with more entrepreneurship will come more failure. That is the nature of our system.
Senator Oliver: Mr. MacKay, my question relates to what you have called a more flexible ownership policy, and has to do with how you justify your conclusion that this really is good public policy.
The example that you refer to in your report is Canada Trust and Canada Trust Financial Services. Even though CT Financial is in the range of the $1 billion to $5 billion that is one of your categories in terms of market cap, that triggers the 35 per cent "widely held" rule. However, in your report and in your recommendations you conclude that it would not be compelled to dilute its ownership block -- in this case IMASCO's 98 per cent, even if it subsequently grew to a size that would otherwise require it to be widely held. How do you reconcile this example with the justification for a level playing field?
Earlier today, in response to Senator Tkachuk's question about Canadian Tire going into banking, you said that what they would have to be careful of would be depositor protection and governance rules. Why would the same not pertain to Canada Trust?
Mr. MacKay: Canada Trust is currently in a zone under the present legislation in which it must have a 35 per cent public flow of voting shares. The "let the light shine in" principle of reporting to public markets is fulfilled in the sense of voting shares for Canada Trust at the moment. That is its current status. Our view, however, was that if an institution presently has a structure that conforms to the law and is in that zone, then, provided the other safeguards presently in place are maintained and continue to be viewed as satisfactory by the regulator, the imposition of a new rule in the system ought not to require them to change their skin as the price of staying in business. Our view was that that had a kind of "retroactive legislation" feeling to it for someone who was a good competitor in the marketplace and was well regulated by a series of undertakings that had been provided to supplement the market float.
It is true that the Canada Trust public float is a different public float than we would be contemplating, because we are contemplating a public float of 35 per cent of the participating voting shares, essentially the common shares, and the Canada Trust float is not comprised of that type of shares. They are offside of our proposed new rules, but we would grandfather them into the system for the reasons I have just mentioned.
Senator Oliver: Having grandfathered them under your proposal, how can that be fair to a new entrant coming in that was not grandfathered? Would they not be given a tremendous advantage?
Mr. MacKay: I do not believe so. We see them coming in with full knowledge of the rules and making business decisions with that full knowledge of the rules. In the case of someone like Canada Trust, there is a change in the rules so that the investment decision is not made with full knowledge of the rules. We do not see that it provides a wide-scale competitive advantage. The issue here is not so much one of competitive advantage as it is to try to ensure the safety and soundness of the system.
Senator Oliver: It would not be widely held, though.
Mr. MacKay: No, it would not. The issue then is whether you can ensure that those who are presently offside of the principles, and might grow to get to the zone of requiring it to be widely held, can be regulated in the fashion in which they currently are regulated. These cases in Canada are very few. There may be one or two. Currently, there is a series of undertakings in hand. We have conditioned our grandfathering on having those undertakings in hand. We have also conditioned our grandfathering so that through time the situation will be rectified.
There is a proposal in Background Paper #2 that contains a mechanism by which, under present ownership and with present undertakings continuing to be solid and supplemented as required, there would be no need for a further dilution owing to a concern about retroactivity and by which we can get safety and soundness in other ways for these institutions.
We have also provided that through time there should be mechanisms so that they would conform to the ownership policies and there would not be a perennial grandfathering.
Senator Oliver: In this grandfathering you would be looking at things like depositor protection and the governance principles that you referred to in the hypothetical example of Canadian Tire?
Mr. MacKay: Yes. The same governance assurances actually can be attained and are attained through the public float that is in existence.
Senator Kenny: I have a question that relates to the bottom paragraph on page 81 relating to wide ownership of large institutions. You state in this paragraph that there is broad public support for Canadian control and you have confirmed this with a public opinion survey. I am looking for clarification here as to what is control. Why is Canadian ownership important, when you can control the activities through regulation and legislation? I am wondering whether the question you have put has to do with control or ownership and whether you differentiated between the two; if you did, what answer did you get? Then, if you would go back to my basic question, why must you have ownership if you can control the entity some other way?
The Chairman: Mr. MacKay, before you respond, I have a question that is a natural piggyback for that one, and you can answer both at once.
In the same paragraph you make this statement about wide ownership:
...the objectives served by wide ownership -- Canadian control and the separation of finance and commerce -- continue to be valid objectives.
To pick up on Senator Kenny's point, it seems to me that the separation of finance and commerce can simply be achieved by law; it has nothing to do with the ownership question. The Canadian control issue, it seems to me, also does not need to do with wide ownership in light of the fact that most major banks, for example, have stocks traded in New York. I do not know what would happen if 52 per cent of the stocks were bought by U.S. shareholders, which has happened to Canadian National and it now has a majority of its shareholdings held by Americans.
I had trouble finding any connection between the objectives of Canadian ownership and the two issues you say are achieved by them, which is Canadian control and the separation of finance from commerce. That is another way of looking at Senator Kenny's point. If you could address both questions at the same time that would be helpful.
Mr. MacKay: By "Canadian control" we do not mean Canadian ownership. We are talking about Canadian governance, Canadian management, and Canadian based. In our Background Paper #1 there is a chapter dealing with Canadian control. We go out of our way there to make that clear. Perhaps we should have made it clearer yet in the final report where we try to pull all these things together.
Under the present Canadian law, specifically the 10 per cent rule, it is possible for 100 per cent of the shares to be owned by foreigners as long as they are owned in 10-per-cent blocks. In our view, those institutions remain Canadian-controlled within our definition, because the law prevents those groups from working in concert. We have a description of something called a "Canadian control tool kit", which is partly ownership but much more than that. We actually have a functional definition of "Canadian control" on page 172 of Background Paper #1 which has a chapter on the subject of Canadian control and the public policy case for it.
Basically, the definition states that a financial institution managed by Canadian-based executives subject to Canadian governance requirements and not subject to the influence of a dominant foreign interest is, for our purposes, a Canadian-controlled institution.
The tool kit I described is on page 178. We call it the "Canadian control tool kit." This is the description of the cluster of measures presently in the law that ensure Canadian control within the definition I have just expressed.
We are not trying to require Canadian ownership at all through this discussion of wide ownership. We are trying to encourage a regime in which Canadian control, as it is defined on page 172, would continue.
To come back to the double-barrelled question of achieving the two objectives described here, we believe that Canadian control is achieved because the 10 per cent rule or, in our version, the 10 per cent expanded to 20 per cent rule, will still preclude a dominant foreign interest control of that financial institution, be it a bank, an insurance company or a trust company, because we suggest the same set of rules should apply to all. We think that is important. We think that Canada derives a whole series of benefits described in that chapter, starting with high quality employment, sensitivity to Canadian interests and the like, that would not be present absent institutions that had that kind of base and focus about Canada, whoever owns them.
On the separation of finance and commerce, perhaps I misunderstood the question, but the thesis we have there is simply that, if you allow 100 per cent ownership of very large institutions by anyone, you are linking finance and commerce because the "anyone," whoever that party is, obviously has another life, another business, another background.
In many ways, the problem is exacerbated where the owner is in real estate or some other business which might create the temptation to draw off the assets of the financial institution. When we address the separation of finance and commerce, we simply say that, if someone has only 10 or 20 per cent, he will not be able to press the diversion of assets to his own other business interests.
Senator Kenny: Would I be oversimplifying your answer to say that regulation and legislation is sufficient and share ownership is not that relevant?
Mr. MacKay: Yes, you are oversimplifying it slightly. The nationality of share ownership is not that important.
Senator Kenny: That is what I was referring to. Thank you.
The Chairman: You referred to your Canadian controlled tool kit, which is on page 178 of Background Paper #1. You speak about the head office being in Canada and three-quarters of the directors being Canadians, et cetera. I happen to agree that all of those things are desirable.
What is the linkage between that and "widely held"? I happen to agree with your definition of control. I do not understand the connection between the objective you want to achieve, which I presume is your tool kit as outlined at the top of page 178, and your presumed way of achieving it, which is wide ownership. I could achieve that with some simple amendments to the Bank Act or the Insurance Companies Act.
Mr. MacKay: Wide ownership is part of the Canadian control matrix at the moment because it prevents a dominant foreign interest. Even with the other parts of the tool kit in place, if you had 100 per cent ownership by a foreign interest or a control block, the ability to force decisions could and would, we fear, trump the other more technical components of the Canadian control tool kit set out on that page.
Senator Austin: With regard to this subject, sir, let me take you back to pages 172-173 in Background Paper #1. You have a definition of Canadian control, and you have put the weight of your views on the phrase, "controlled by Canadians." You quote Michael Mackenzie on page 173. If you read the paragraph, the weight of his comments is on domestic ownership. He says:
I also think that domestic ownership of clearing banks is important to the Treasury, Finance and central banking authorities around the world because of the importance of such banks to their economies and payment systems.
The word "ownership" switches back and forth to the word "controlled." This is also the case in regard to the comments about the financial system inquiry in Australia. The key word in that first line is "ownership."
Pursuing Senator Kenny's line of comment, you can imagine that, in a global institution world, we have moved beyond the multinational level and are now talking about global corporations. A global corporation would not be the slightest bit concerned about anything but ownership of the fruits of its investment. We could have Canadian control, in a sense, but ultimately in our system, as you know as well as anyone, we accord ownership special rights and privileges.
Have you considered whether your definition would not at some time lead to a clash between those who are controlling and the ultimate rights of owners in our corporate and mercantile system, and whether we would have let down our guard? I am talking only about the core financial institutions upon which the management of the financial institution system rests.
Mr. MacKay: Let me make it clear that we are not recommending any change to the present system as far as this ownership question is concerned. Whatever these problems may be, they exist now, and I suspect that Canada's trade agreements would militate against new ownership restrictions as opposed to refinements to the Canadian control part.
On page 78 of our report, we note the current shareholdings, foreign ownership, as of July 1998, of the large Schedule I banks. At that time, the Royal Bank was 24 per cent owned apparently by foreign shareholders; the highest was the National Bank, at 35 per cent foreign ownership.
Senator Austin: Why did you not use the word "ownership" in the last paragraph of 178 instead of the word "control"? Why did you not say: a substantial shift of the "ownership" over Canadian financial assets to foreign interests would not be in the best interests of Canadians?
Mr. MacKay: Page 178 of what document?
Senator Austin: It is Background Paper #1.
I believe there is an insidious virus in your recommendation that, basically, you will set up new standards of control that will not protect the essential financial system. As you point out in your paper, no country would cede ownership of its clearing banks and its payment system. You move over to control and you can see a world in which control is one thing and ownership another. Suddenly, we are in a conflict with the world.
Mr. MacKay: Again, if there is an insidious virus here, we are already infected. The present Bank Act of Canada operates in a fashion that has exactly the problem -- that is, if it is a problem -- which you are describing.
Senator Austin: You are taking me right to the 10 per cent issue, which I would be happy to discuss if Senator Angus would allow it, or I can return to that matter later. This leads to the expiration of whether or not you are enhancing the risk by allowing the larger ownership with its compounding effect. An investment group such as Blackstone could own 20 per cent and General Electric Financial Corporation could own 20 per cent. We have changed the character of ownership from "widely held" to "more closely held." Whether they are acting in concert by agreement or by mutual unilateral behaviour because the rules of the financial industry do not vary greatly, they will all come to see their interests. They may come at it separately but they will see their interests more or less in the same fashion.
Do you think I am an alarmist, or does this area concern you?
Mr. MacKay: The 10 per cent rule is one of those rigidities in the system that denies our institution the ability to make constructive alliances in an international world in which alliances short of ceding control are an important way to pursue strategies.
We do not think it will be beneficial for Canadian public policy if we keep so many rigid rules in place that the only possible strategy for large institutions trying to become more cost productive and deal with the change forces is to merge with each other. By opening strategic options while maintaining -- as we would see it -- Canadian-based mind and management, which is what we think we will do within our framework, we think we will have liberated the system without putting at risk the Canadian nature of the system.
Why is 10 per cent a good number? Why is 15 per cent a good number? Would 30 per cent be a good number? We debated the number. Our conclusion was that, just as 20 per cent is a threshold shareholding up to which you may acquire without invoking any securities law implications because it is not viewed as a takeover because it is not viewed as dominant, if you permitted a few of such blocks you would be eventually permitting, in the most exaggerated case, eight groupings to own a Canadian large financial institution as opposed to 10 under the present law. That mathematical change would not put at risk the Canadian base -- that is, the very important Canadian mind and matter of the institutions.
Senator Austin: That takes us into a wide area of discussion, because the hip bone is connected to the thigh bone, and we are now down to the thigh bone. It raises the question that must be pursued -- and I will not pursue it now -- namely, why what you call "alliances" require Canadian equity contributions. In order to participate in international business, why do Canadian banks need to be larger continental or international players? What you are doing with control, as I now see it more clearly, is facilitating larger scale operations, which you hope will remain controlled in Canada.
Mr. MacKay: Not necessarily, but it is one possibility.
Senator Austin: But you are allowing the offering of equity in Canadian banks to acquire foreign assets; therefore, you are increasing foreign ownership.
Mr. MacKay: We are permitting the offering of equity in many contexts. It could be an alliance with foreign banks; it could be an acquisition of a large institution. It could, however, also be an alliance with a supermarket, to come back to the other people; or, it could be alliance with an information technology company, domestic or foreign. It can open the pores of business strategy. Public policy should not steer institutions away from legitimate business strategies unless the public interest is imperilled.
Senator Austin: That is what we are trying to examine here, namely, where is that public interest in diminishing ownership in favour of a theory of retaining control? That is the exactly where we are.
Mr. MacKay: That is the theory of the present legislation. We do not think we have diluted it at all. We think there are significant strategic options open without causing any possible harm to Canada.
Senator Austin: As you have pointed out, it is much harder for real ownership to be attractive to foreign players, whatever their motives, at a 10 per cent hurdle rate than it is at a larger hurdle rate. That is the area that concerns me.
The value of the 10 per cent rule is that it is effective in creating a barrier to foreign ownership. Your control definition must be looked at carefully in terms of public interest.
We are getting into one of those "six of one and half a dozen of the other" discussions. I should like to make that point and come back at another time.
Senator Angus: I should like to add my word of welcome to you all, and to your colleagues, and to congratulate you on the imposing piece of work here which will tax and bend the mind of even the Banking Committee of the Senate. I am sure it already has done so.
I should like to probe an area that might shed a little light on the underlying philosophy that has driven you to your recommendations. It might help the public and this committee to understand where you are coming from. This flows from your opening statement, Mr. MacKay, where you state on page 5 that:
Being in the financial services business is a privilege, not a right. With that privilege come responsibilities -- business responsibilities and social responsibilities. Our financial system will work best when it has the full confidence of Canadians. We make a number of recommendations about corporate conduct --
That is a broad statement. You have indicated to us that you had a big debate in house on what is the public interest. All of your recommendations seem to be driven by the public interest.
I was reading your statements the other day -- and this is in the report as well -- that, if the public interest comes into conflict with the commercial or the private interest of the institutions involved, then the public interest trumps.
You talk about being in the financial services business as a privilege and not a right. How far does that go? We are now hearing about defining the financial services business. Is car leasing included in financial services?
I realize this is, perhaps more of a "macro" area and a somewhat philosophical question, but I need to understand.
Mr. MacKay: It is a fair question and a basic starting point. If you go back to the discussion paper of the task force, you will find the task force had already positioned itself in its discussion paper in much this way.
In Canada, as elsewhere around the world, this is not a business which you get into by setting up shop. You must seek permission. It is a privilege, and there is an approval process. This is because, as Senator Tkachuk mentioned, the moneys of Canadians are being taken as deposits or they represent the long-term stakeholder in an insurance context. This has created an environment in which there is a major front-end approval process which determines those who are fit and proper and who can cross that bar.
Senator Angus: This is as the system is presently constituted where institutions are narrowly defined as banks and deposit-taking institutions.
Mr. MacKay: Actually, it is likely to be constituted in this way when some decisions are finally made as to whether it will be necessary to license, as financial institutions, software providers, all of whom want to provide access to a smart card. Someone will think about the regulatory implications of that and decide that, perhaps, not everybody should be in that business either. It is not on today's agenda because no one quite understands how that will unfold.
As we considered the words, "privilege" and "not a right," we had two things in mind. One was the mechanism of getting into the business and the very careful control which has been put on that and is still put on that.
The other was the fact that the privileges which were built up here were not just related to getting into the business, but were also related to the rest of the apparatus that surrounded the business for so many decades in Canada. Once you got into it -- which was a privilege -- another set of privileges then emerged which kept other people, especially foreigners, out of it.
Those two things taken together created an environment which led us to the statements you have just described. I am not sure that fully covers your question.
Mr. Pierre Y. Ducros, Vice-Chair, Task force on the Future of the Canadian Financial Services Sector: I would add that, historically, the banks were the only ones who had access to the payment systems. The deposits were insured by CDIC. They had protection from foreign bank entries. They had, historically, tremendous privileges which were also useful to the rest of society. They created safety and soundness in our system, but it was very much a privilege for them.
Senator Angus: That is exactly right. As constituted, the main elements of our banking system have understandably been subject to these obligations which you have described. That is the counterpart, if you will, of the privilege.
Now you are talking about this incredible change and the need to hurry the change along.
Another matter you mentioned this morning may, I think, go hand in glove with this. You posed it as a question which I believe you answered affirmatively but perhaps you can confirm that. Your question was: Do we want an entrepreneurial culture or do we not? Your persuasion is that, yes, we do. I hope that is right.
Mr. MacKay: Yes.
Senator Angus: If we are to have an entrepreneurial culture and yet there is this privileged element, and we do not know how far it extends, that is where I get into trouble. We must also take into consideration the difference between a financial service and a commercial service. I realize it is dealt with in the fine print of your report at large, but could you just expand on that a little? We do not want to dampen the entrepreneurial spirit and put up so many road blocks and regulations that none of these things will happen.
You have even presaged that, despite road maps and direction signals, it will all come down to the human element. If there is inadequate leadership and motivation by management to get into these fields, nothing will happen, and we will make things worse instead of better.
Mr. MacKay: That is quite right. Let us take a look at the front end. *As well as this rule that says you cannot get into this business of, say, banking. You probably have all heard the number that I have been quoting and are not interested in hearing it again, but we have had three new banks in Canada in the past ten years. The U.S. has had over 1,400 including 207 last year. That is a heck of a bad record. We should be able to spawn some institutions that will have some success.
You may ask what is wrong here. We start by saying we think the ownership policy is wrong but there are a lot of other things that are wrong, too. We tax capital very aggressively in this country. Capital is what makes a strong financial institution. If you tax profits, that is different. Taxing capital saps the strength of a new institution the moment it gets into business.
We have "one size fits all" regulation. There is too much and we need to get rid of that. There are a whole bunch of things we need to do to facilitate entrepreneurship if it exists.
You cannot make entrepreneurship happen. We cannot wish it on the Canadian public through any recommendations we would put on the table here. However, we are persuaded that Canadians have an opportunity to be significant financial service providers, not just through the big corporate vehicles that have come about through the use of this historic privilege but through new enterprise.
Are we going to burden the new enterprise with so much newfangled regulation that no one will want to be entrepreneurial? I take that as the thrust of your question. I do not think that is so. We will, however, want to ensure that anyone new who gets into business and who wants to take the deposits or take money for long-term insurance purposes is quite well regulated and has got an effective apparatus built around that system on, say, privacy.
Senator Angus: I hear what you are saying. You posed a rhetorical question, and it came up again in your last answer, about whether or not we want an entrepreneurial culture.
Mr. MacKay: We do.
Senator Angus: I am persuaded that we punish entrepreneurial initiative in this country in a major way. That is why we find ourselves in this dilemma. I am afraid that you are caught in this balancing act. We tend to bend over backwards -- and I am not saying it is wrong -- to strike a fair balance between consumer rights and interests and the other side of the coin. However, are we going to put up more barriers?
I like your direction toward opening it up, liberalizing and deregulating. As I read your report, I was thinking that you were speaking my language, until I recognized the plethora of other factors which flow from the distinction of right versus privilege. It is almost as if you wrote the "open it up" philosophy, including the suggestion that we stop punishing and start encouraging entrepreneurial initiative, and then you reacted to what you had written, perhaps thinking you had gone too far, and you then started to set up roadblocks.
The Chairman: I had exactly the same reaction. I will give you a specific, illustrative example. I listened to your response a minute ago about encouraging people to own new institutions and about not burdening them with a lot of regulation. Then I read your Recommendation No. 93 which states that any federal deposit-taking institution which wishes to close a branch should give four months' notice.
I point out to you that the Northwest Bank of Detroit, which has become quite successful, does not even talk about having "branches". It talks about having "stores". I would compare the whole tenor of your report to that distinction as it reflects on retail services. Suddenly I find that this is a retail business.
I am with Senator Angus: I think you suddenly realized that moving into the retail area and talking about a competitive marketplace and so on was good, and then you said, "Holy smokes, we cannot allow these guys to start doing things that could cause political problems, such as closing branches." Now you say, "You can have a retail business, but if you open a store, you cannot close the store for four months." That is a huge disconnect and inconsistency, and I am with him. I liked your basic thrust until I got to chapter 8.
Senator Angus: You talk about the U.S. and the 1,300 new banks over a short period of time. We did a comparative study, and the same thing struck us. However, we know why it did not happen in Canada. It is because of all the restrictions that are here and of which the chairman just enumerated a typical example.
Mr. MacKay: What is the question?
The Chairman: You can either take the question as, "Why are we right?" or "Why are you wrong?"
Mr. MacKay: Let us go back. Closing branches is not a political problem; it is a community problem. If you live in one of those communities, you understand what a traumatic issue it is for branch closures to occur, especially in rural and remote communities. That is not a political problem.
The Chairman: You said "in those communities", and then you immediately leapt to talking about rural Canada. That I understand. Are you referring to closing the branch at O'Connor and Sparks? There is a huge difference between that and closing a branch in a community that might only have one branch, for example.
Mr. MacKay: Community issues can vary; for example, if you close a branch at Jane and Finch or some other difficult urban areas. It is not just a rural problem. It is probably a more pronounced problem in small communities.
Let me back up. The elements related to privacy, tied selling, transparency of documents, et cetera, are all issues and areas wherein the financial institutions already purport to do most of what is required. If you go through those elements one by one, there is no massive imposition of new ideas. We have pushed the edge of the envelope a little further and made it a requirement, not a rule of good practice, that it be done.
However, if you read the codes that emanate from the Canadian Bankers Association, you would assume that 95 per cent of what we are proposing is being done anyway. Either they are not doing it or they are. If they are not doing it, they should be. Every one agrees with that. If they are doing it, the incremental cost to do it under a legislative regime that will give people some confidence in the regime will not be very much.
You can take the ombudsman as a classic example. No one will believe that an ombudsman system run by banks will be a fair and impartial ombudsman system at the end of the day. There ought to be no more cost for the banks to fund their share of a fair and impartial federal ombudsman system than to fund their own system. We have not burdened anyone.
If you look at the entrepreneurial culture to the south, they have had a CRA for a long time. They have federal reserve requirements that must be followed. Go down the list. The United States is an environment that has legislated heavy-duty consumer-fairness protection regimes, and it is entrepreneurial. You can have both at the same time.
In Canada, we can have both at the same time. Quebec, which legislates in these areas, is an entrepreneurial place, and I suspect it will spawn many of these new financial institutions.
Senator Meighen: Are you satisfied from your work that the inevitable increase in the level of failures that will come from a more entrepreneurial system will be tolerated by Canadians? You cannot have one without the other, but I do not know that that it is an appreciated fact. I am not sure how we can convince people that more entrepreneurship will bring a greater number of failures. From what I have heard so far, in essence you would ring-fence smaller institutions so that you contain the damage.
Mr. MacKay: Yes.
Senator Meighen: Is there anything else that I have missed that you proposed to contain the damage and to limit the losses?
Mr. MacKay: The only thing we considered is that the need for regulation tailored to small institutions can mean less regulation in certain respects and more intensive inspection and other traditional regulation in other respects. When we mentioned the need for OSFI to tailor its regulation, "tailor" does not mean lighten. It means having the right kind of regulation in place for a smaller institution. That is the only other thing that, as a task force, we actually discussed.
Let us put it this way: At a certain point, Canada must say, "How timid do we want to be? Do we want to just stick with five huge institutions and two or three very small ones, and that is good enough, or will we open the doors here a bit?"
We believe that your point is correct about the need to ensure that there is a public understanding that the spawning of new institutions brings with it the risk of failure. You do not always point the finger at OSFI, the federal regulator, and say, "You failed." It is awful and it is ugly. We have a deposit insurance system in place in Canada that has well defined limits to it, and I believe people operate in that system. Other things being done in that system are designed to encourage prudence.
The short answer to your question of have we any further suggestions on how to either comfort the community about this failure ratio or educate the community or better regulate the institutions beyond what I have said is that we do not.
Senator Meighen: You made reference to deposit insurance. Perhaps I missed this in the report. Did you consider whether your suggestions generally would require any change in deposit insurance, either in the amount insured or in a different level of insurance across the spectrum, depending upon the institution?
Mr. MacKay: We realize that insurance companies are increasingly providing deposit-like instruments. Currently, the deferred annuity seems to be a very close fit to the GIC, and if, as we propose, there are insurers in the payment system, they will have $30 billion annually which is eligible to be treated as a quasi-deposit. Not all of it will be, as much will be paid out, but some billions of dollars will be held by large insurers as, in effect, deposits. You and I will write cheques on that insurer.
The only thing we have identified here is the need, as that new competitive force is put into place, to ensure that there is equivalent deposit protection for the deposits that are held by insurers as the deposits held by banks.
Senator Meighen: One question leads to one answer, which leads to another question. In terms of the payment system -- and I realize it is not directly the topic we are addressing this morning -- you mentioned insurance companies having access to it. Do you see them being admitted as a class or on an individual basis, and by whom?
Mr. MacKay: Obviously this is opening a new door, because in the past it has been the deposit-taking institutions, and it was subject to a certain number of tests there too. However, we would see life insurance companies, generically speaking, as passing muster. There are issues to be sorted out, but they strike us as not being beyond the pale.
Currently, inside the payment system you may have very weak deposit-taking institutions. The manner in which they get their cheques cleared depends upon the arrangements they make with the direct clearers. We do not think that would be any different. In effect, if there were weaker insurance companies inside the system, they too will have to work out mechanisms with direct clearers, assuming that that concept remains in place, to clear the cheques. That may be costly and prohibitive, and for some not practical.
Senator Meighen: If they do not have it, they will not be in the system.
Mr. MacKay: We also do not believe that all insurance companies will want to offer a payment service. That is a reasonably sophisticated product. It is more likely that the larger insurance companies will offer that service. They will probably not present any payment system/solvency issues.
Senator Meighen: Have you held your recommendations, particularly in relation to ownership, up to WTO and NAFTA undertakings to see how they fly?
Mr. MacKay: We think that they fly well. However, we have not done an intensive legal review. We have not gone out and obtained an expert opinion on the subject. However, we have had discussions both internally and with finance that lead us to think they are fine.
We are really not breaking any new ground. These are not ownership restrictions in terms of foreign ownership of our institutions. The 10 per cent rule and our 10-20 rule are exactly the same in that respect.
Senator Kroft: My questions follow on the subject of acceptability of the concept of failure. My impression, gained over a long period of time in one type of interface or another with officials in the Department of Finance, is that we have an historic attitude built deeply into the financial administration and prudential structure of this country that we must do whatever we can to ensure that there is no failure, and then all other legislation moves from there.
Do you think that you have quite a fundamental cultural change to bring about, not so much on the public opinion side as in the hearts, minds and culture of the regulatory side, in order to talk so casually about the fact that real life involves failure?
Mr. MacKay: I would agree with you that there is the need for everyone to think about how they see allowing a more competitive marketplace. For that reason we have urged that the statutory mandate of OSFI be more clearly defined.Competition and innovation and the facilitation of competition and innovation is clearly a factor to be taken and put in balance with safety and soundness. We are concerned that there should not be a preoccupation with safety and soundness of every institution as the be-all and end-all of the regulators' work.
It is of interest that with the new Australian regulatory authority, balancing of competing demands of the sector are put expressly into the statutory mandate. We understand that the same approach is likely with the financial services authority in the U.K.
Having said that, we have expressly held back from urging that OSFI should promote competition. Putting it in the balance to facilitate competition and not standing in the way of genuine competition is what we need to focus on with the regulator as well as with the broader public. Is it a big cultural change? It is certainly a change of culture. However, we think it is a necessary change of culture.
Senator Kroft: My other question is macro in the extreme, and really underlies everything we are talking about, particularly in terms of acceptance of power relationships and the influence that institutions have in our lives. We are engaged in a public policy process and hopefully an informed one that will lead to legislation and regulation. However, the process is a political one.
On pages 58 and 59 of your main report, you briefly analyze the standing of the Canadian financial system in terms of other systems on a range of items such as cost service. You can fairly say on that range that we come out reasonably well.
On page 59 you make the comment that "...there is a striking antipathy toward financial institutions, in particular toward the banks and their leaders."
In the course of your work, have you and your colleagues reached any conclusions on what impediments there may to the work of legitimate reform in this country? In turn, what can be done about that?
Mr. MacKay: I wish I could answer your questions with some precision. I would refer you to the survey that Ekos did for us; it posed a number of questions relating to attitudes. Ekos' research showed that the attitude toward the institutions was less aggressive and more tempered than I anticipated; significant satisfaction was expressed, particularly with credit unions.
It was determined that institutions are considered quite competitive. While the CEOs of the banks were not liked, the branch managers were. The study demonstrated a kind of schizophrenia about the institutions and was not as negative on the institutional side as had been anticipated. Perceptions were very negative and distrustful in terms of the leadership of the institutions. Whether that comes from media coverage, which neither they nor we have any power to control, or is derived from something else, I do not quite know.
It is important to find more structured ways to build bridges. We discussed whether the community reinvestment legislation was the structured way to build bridges -- it is one structured way to build bridges -- or whether we should have a somewhat different mechanism. This is what we eventually proposed.
We need more than an advertising campaign. In the midst of our work, the Canadian Bankers Association began an advertising campaign. However, we think more than that will be required in a dedicated, long-term effort.
The attitudes towards the credit unions are quite different than attitudes towards the banks. If you look at issues of the price of products from the credit unions, or any other quantitative measure of service, you do not find that the credit unions are doing something better for their customers than the banks. Indeed, in some respects, the banks will be more ahead on quantitative measures than the credit unions.
The National Quality Institute has determined that when people are asked for their attitudes towards the credit union movement, it is number two or three out of 21 industries and the banks are down at 18 or 19.
Relationships built from the ground up are terribly important. The turnover of small business account managers seems to be a critical issue. I believe the banks agree that they have a significant problem in that regard. The small- and medium-sized business community is irritated in the extreme when they educate one account manager to understand the business and, two years down the road, perhaps for good business reasons of the bank, he is replaced by someone who does not have any opinion on the credibility of the individual involved or know what the business is about. The client will get no constructive feedback, he will not have a quasi-adviser in his banker, and he will be left to deal with someone who is another doubting person.
Our attitude is you must build relationships starting from the ground up, you must find some new means to build relationships. We propose community accountability statements. However, there must be a way to help bridge the gulf because the gulf does exist. I go back to Ekos and say it is not quite as bad as I imagined. Our statement does not overstate the situation. The antipathy exists, but it is directed more to the leaders than to the institutions.
Senator Callbeck: My question concerns comments that were made about the access to capital for small business. This summer I participated in the hearings in the Atlantic area. We heard from business people and business groups about the problem of access to capital. You indicated in your findings that small business with high risks certainly do have problems in this regard. You mentioned the possibility of higher interest rates -- the higher your risk the higher the rate.
You also mentioned the Community Investment Act. I know that you have ruled this out because you feel that there is not enough evidence to bring that into use in Canada. When we were in Washington and heard from representatives of the Federal Reserve Bank they told us that banks were very hesitant about this act but that they have come around. The bankers' association told us that they have no difficulty with it, and that they think it should be extended to the four pillars.
One of the problems that was mentioned during our hearings in Atlantic Canada related to the tourism industry. Would that Community Reinvestment Act not solve many of the problems in the tourism sector? Why have you ruled it out completely?
Mr. MacKay: We decided to face the questions we had to consider and get the best answers we could to them. In some ways, we recommended something that is much broader than the Community Reinvestment Act. That act is a statute which requires reporting by banks against certain measured criteria. Our analysis shows that banks provide some 50 per cent to 60 per cent of financing to small businesses. The remainder is provided by a whole other series of providers; some are regulated, some are unregulated, some are regulated by the federal government, some by provincial governments. We have proposed that there be a new information-gathering mechanism put in place by Statistics Canada that would comprehensively collect data by region and sector, not only from banks, but from the whole range of providers. It will be far broader than the Community Reinvestment Act in the United States and will provide a comprehensive, across-the-board database that will be unparalleled for public policy review in Canada, as well as for institutions themselves to help make business decisions. We have coupled that with the community accountability statement idea, which also deals with a number of topics that are not in the Community Reinvestment Act.
Coming back to the data available to small businesses, the lack of good data in Canada is appalling. We need data but not just from the banks, we need it from the life insurance companies, from the specialized financing corporations who are now providing some 15 per cent of credit to small businesses across Canada, from the credit union movement, from equity providers. We have a broader solution to a somewhat different problem.
Senator Callbeck: It is broader but does it have any teeth? My understanding is that, under the Community Reinvestment Act a certain percentage must be invested. We were told that even mergers have been held up in the States because banks have not fulfilled the requirements of this legislation.
Mr. MacKay: On the merger front, we have recommended a more aggressive approach than the United States' approach through this public interest review process where one could analyze many factors, including branch closures or small business financing provisions, or whatever may be considered to be the major public policy issue. From our point of view, we think that, in letting the light shine in on the institutions, we will have a concentrated sector, there will be a contest to be good and not bad, and then a focused public interest review process in the merger context will provide quite sufficient sanctions.
In the United States there are no sanctions year by year if you do not comply. It is when you hit the time for your acquisition or merger that the possibility of having to enter into a dialogue and make commitments comes into play.
[Translation]
Senator Hervieux-Payette: The status of manager in the whole banking organization is never the same as that of the caisse populaire managers or even the insurance brokers. Not only is there no long term relationship, but you don't even have the satisfaction of dealing with someone important within the organization. Whether it's McDonald's, Canadian Tire or so on, managers are the champions of organization. You never hear about the vice-presidents and in a bank everybody wants to become vice-president.
Maybe they could use a few tips on organization. The perception we have is that the client is there to serve the bank and not the other way around. It's the only business where they condescend to do you the favour of serving you and their doors are open for business at the time convenient to them. If you work from nine to five and you only have an hour to do your banking, you can be sure there will be 50 people lined up at the wicket. Maybe it would suit you to go there at 9 a.m., but the bank isn't open. They do not understand what service is about.
I am sharing this with you because I think it is important for such a major institution to regain its prestige. I know that some bankers are exasperated at being depicted as villains, but it is not by spending 20 million dollars on a TV publicity campaign and sending pamphlets to our offices that they will regain their prestige. That certainly is not a bad thing, but they still have to deal with personal contact in the whole matter of the people on the floor. The main player is the local one. Whether it's a small town or a big city, it is important to develop trust, an individual relationship that will make the client feel that he has a say in the decisions.
You have managerial rigidity. As soon as it goes a quarter of an inch beyond the mark, you have to go to the regional and even the national level. In my opinion, as long as this question has not been addressed by all banks, they will not have solved the relationship problems with their clients.
You talked about community banks in the U.S. and caisses populaires. In the latter case, the return is not necessarily extraordinary, but everybody likes their caisse populaire manager, who has become almost as important as the curé, the parish priest, used to be in the old days. I don't know if Mr. Ducros has the same impression as I do. We are from Quebec where they have caisses populaires. Do Quebecers have the feeling that this financial institution that represents almost 50 per cent of all financial institutions in Quebec has a better reputation?
Mr. Ducros: The fundamental concept of the report is to give more power to the consumer. The definition of consumer, as provided for in the wording, is the client of any financial institution whether it is a bank, an insurance company or some other entity. So the individual, the consumer or the client is the central focus of our concerns in this whole thing. Maybe that is why you'll find a balance in the structural recommendations in the report as well as consumer protection. There is also a complete chapter on the expectations of Canadians concerning the future of the financial sector.
The most specific recommendation we're making is to give more power at the local level. We strongly recommend that financial institutions delegate the power to make loans to the local level, and remain closer to their costumers at that level.
We are asking that the financial institutions have career plans for their staff and serve small- and medium-size businesses in such a way that account managers, branch managers and so forth remain far closer to the community they're serving.
Senator Hervieux-Payette: I find nothing in your report on how we could empower consumers. As we speak, consumer associations in Canada are weak. Their means, their chances for survival are not the most solid. They depend on the private sector and rely very little on the government. Consumer associations have almost no money. If I compare what is being done in Quebec to what's being done at the national level, whose responsibility it is to see that consumers are protected, I do not get the impression that it's a very vibrant and strong structure.
During your meetings with the associations, did you get the impression that they felt properly equipped to deal with the role you would like them to play?
Mr. Ducros: Two points should be raised. First, that we have to find a way to empower the consumers as individuals. To manage that, ways must be found to make it more of an even match between the financial institution and the individual consumer than is now the case. The divulging of information and transparency of documents are extremely important in our mind to allow an individual to choose the institution he wants to do business with, because that is the one that answers his or her needs best. The documents we presently have are not clear enough. They do not give enough information, for example, on interest rates. A way must be found to give more power to the consumer, to give him responsibility for his own decisions.
The second point is that it would be to the advantage of many consumer associations to get together and work more closely together. We did not think it was necessary for government to fund them directly to accomplish this. There is a lot of work to be done to get those associations together before attaining that objective.
Senator Hervieux-Payette: The forces are not balanced. The Bankers Association contributes 20 million dollars to and association to promote their own views. I get the impression that the match is not quite even. I don't think that, in all of Canada, there are 20 million dollars made available at the grassroots level to conduct studies, give out information and train ordinary people. You need facilitation to do that and, from where I stand, I do not see any.
[English]
Mr. MacKay: To supplement what Mr. Ducros has already said on this subject, we agree that strong and informed consumers, both individually and collectively, create a balance in the marketplace which is a force that ensures better competition. It is not just a matter of being sure that consumers are treated fairly; it actually puts a strong competitive tool into the marketplace to have knowledgeable, well-informed consumers, and effective consumer advocacy groups.
As Mr. Ducros has said, on the individual front, we have recommendations dealing with the transparency of documents. We also have recommendations, for instance, for those who deal with customers, to ensure that they are well trained and can have an effective and meaningful discussion and disclosure of the product.
On the subject of consumer organizations, some consumer initiatives are found in the report. The funding problem has been recognized, and we have urged Industry Canada or the Department of Finance, depending on who has responsibility -- and it may differ with the issue -- to ensure that the effective participation of consumers in a multi-partite process to improve the clarity of documents does not suffer because of lack of funding, and that there be clear project grants for that purpose.
On the broader front, we considered two possibilities. The first was the establishment of a special consumer bureau inside the federal government. Given the divided jurisdiction in Canada for consumer issues, we were reluctant to suggest such a new entity. However, we did look at and give some nod of approval to an idea that came forward from one consumer group -- that is, that a financial consumers organization be formed that would be active in representing consumer interests in financial matters. Our concern was that the organization be inclusive of many consumer groups and their interests. As Mr. Ducros has said, we urged them to collaborate with each other and to come forward with a proposal to the federal government as to how that might be established. Their idea was that the government might require financial institutions to include, in mailings to their customers, a flyer that outlining that for $2, for example, a consumer could join a financial consumers organization which might then become self-funding without any financial burden on either government or the financial organizations. A more active group of consumers in the marketplace would be very good for Canada.
Senator Tkachuk: I wish to get back to the question I asked first thing this morning. In the banking industry, safety and soundness is extremely important. In other parts of the financial services industry, you want more competition and openness. Sometimes, the two do not fit.
If a bank finds itself in trouble, something that has happened in the past, and we have the widely held question of ownership, does that not prevent other foreign banks from saving that bank, as Barings Bank was saved by ING? In terms of the safety and soundness issue, you would think it important for another financial institution to take over the assets of that bank, having enough financial capital to ensure the safety and soundness of that institution. In that way, depositors would feel good about having their money held there, which would in turn prevent a run on the bank. Otherwise, it would be limited to just Canadian banks to do that.
Mr. MacKay: That is a good point. It is one with which we wrestled. We have proposed, on page 87 of our report, that there be an exception to the wide ownership rules, or at least an ability to find a white knight in such a case from foreign financial institutions and not just to have to look to a very small number of Canadian financial institutions. We recommended that the Governor in Council would have to give his approval to that transaction. We were concerned about exactly that point. In a sector that is already concentrated, if one of the largest Canadian banks were to fail, being forced to look to the very small number of other Canadian institutions to pick up the pieces could prove a burden; therefore, there should be a safety valve.
The Chairman: For the record, that is exactly how the Hong Kong Shanghai Bank got into retail banking in Canada. When the Bank of B.C. was in significant financial trouble, there was an attempt to shop for a solution among the Canadian banks; that led to the situation in which the best solution was the purchase by a foreign bank, namely the Hong Kong Shanghai Bank. So there is a precedent in Canada for exactly the situation Mr. MacKay has just described.
Mr. MacKay: I understand that was by a special act of Parliament. However, we would have it as a safety valve in the legislation because, as you will recall, with Barings it was an over-the-weekend exercise that had to go on. That is our proposition.
Senator Tkachuk: "Widely held" is good unless you are looking for someone to save you.
Mr. MacKay: Even in this case we have required a widely held foreign financial institution.
Senator Tkachuk: When they come in that is what would have to happen.
Mr. MacKay: Yes.
Senator Tkachuk: You mentioned the competitive forces that were out there, that the banks were suffering because of fewer corporate loans than they had had before, and that they had more difficulty attracting capital. That may just have to do with mutual funds and the attractiveness of the market. They might have a rush of capital over the next five years that they did not have before. Credit cards is another issue.
In other words, while the very reason they are in banking is to extend credit and get deposits, that is where the problem lies. They have a problem keeping a large part of their market share, so now they want to sell other products because the products they are supposed to be in the business of selling seem not to be working out that well for them.
Mr. MacKay: You have your finger on one important reality, that large banks and full service banks have many products. I have heard some say they have 25 or 30 product lines. As with any other business, some of them will go up, some of them will go down, and some of them will disappear, because other people will come and take their business. That is what is happening in the banking business today. It is a reality of that business.
I do not think that necessarily leads to the conclusion that you need new business lines. That is certainly not the basis for the rationale in any of our recommendations. In our recommendations we just start with the customer and provide the choice and the competition in the marketplace to get the best product for the best prices which will provide you with a better marketplace for the consumers of Canada.
However, there is no question that, if looked at through institutional eye glasses, you had better be alert to new business opportunities because you will be losing some of your old business opportunities. It is probably no different from businesses you have been in or my own business. If you are in the legal business, there are times when you had better be in the solvency business and other times when you had better be in mergers and acquisitions.
Senator Tkachuk: Banks are essential to a healthy financial marketplace. I am not attacking the banks, but when they fail at their business, rather than having to put out better products to get the business back, we are giving them easy ways out.
So if they are not making much money lending money to corporations and small businesses, they end up taxing capital so that every time there is a little transaction they get 40 cents or 50 cents. That is a much easier way to make money than making a corporate loan and spending a lot of time with the businessman ensuring that his business is going well. It is easier simply to tax the capital as it flows through.
We are allowing them to get into all this other business with our deposits rather than the very essence of the business they are supposed to be doing, which is extending credit and ensuring that our assets are safe for the Canadian public.
Mr. MacKay: You mentioned service charges, saying that banks may be looking for ways to enhance their revenue flow by attaching service charges to things they do for people which they previously did without a service charge.
We commissioned a very interesting study on service charge levels in Canada as part of our effort to understand in what respects the Canadian banking system serves Canadians well and in what respects it does not. We got some pluses and minuses.
The service charge study showed that Canadian service charges were about in the middle of a group of eight or 10 countries that were studied. The United States was the highest, the European countries were the lowest, and we were somewhere in the middle.
Is that the point you wished me to respond to?
Senator Tkachuk: I would like you to talk a little more about my point that allowing banks to get into other product lines that really belong in the financial service industry is a threat to the banking system. There is a higher risk and that will not give assurance to consumers that their money is safe.
Mr. MacKay: We are not proposing very much of that at all in this report. That, as you have correctly said, is the legacy of earlier reforms. Neither have we urged that they be rolled back. There are only two add-on products, if you like, that are involved in our report. Let us start with insurance. Currently under the law, banks can be in the business of insurance. They just have to do it through subsidiaries that compete head to head with other life insurance companies or property and casualty companies. Many of them are doing that, although not all. Our recommendation is that they may, within very strict rules and subject to privacy and tied-selling guidelines, actually sell it at the bank branch level. But that does not change the product line from what they are presently in at all, so it does not expand the risk profile of the banking operation because the insurance is currently done in a subsidiary. So that is not increasing the risk profiling.
The leasing activity is a new activity. We think it is not generically different from leasing all the other products that they currently can and do lease, and that are leased by banks in other countries. So we think the present range of reforms we are proposing for banks does not increase the risk profile. I would agree with you that the breaking down of the pillars in 1987 and 1992 has increased the risk profile by broadening the lines of business.
Senator Hervieux-Payette: Mr. MacKay, you said a study was done on the service fees and that Canada was ranked in the middle. My impression is that it is not the service fees per se that lead to this finding because it is difficult to compare those fees. Were you able to compare them? These fees are usually fees for an aggregation of services that you cannot compare to the aggregation of services of other institutions. I have not seen this study.
Mr. MacKay: Approximately two studies have been done on our behalf. They are reported in our background papers and are outlined in greater detail in the work of our consultant. In Background Paper #1 there is a summary of the service fees for individuals on page 78. Elsewhere in the report there is a small business comparison.
This was seminal work where we made an effort to distinguish a standard basket of services to try to obtain a response that permitted a meaningful comparison. Do not press me on my having cross checked all the methodology, but it appears to show us in a middle ranking for some items. The survey showed that the Canadian loan spreads are near the lowest in the group of countries studied. On credit card spreads, they are high. They are a couple of points above the United States spreads. The research is interesting. It breaks out some of the products and gives us a feel for the pricing efficiency of our institutions, and it is not bad.
Senator Hervieux-Payette: Could we have that information for this afternoon? We want to be able to study your information because it strikes me that there is nothing similar in the marketplace right now. In one place I can be offered four services; in another five; and in another six. They are not the same. As a consumer, how can I can learn which one is offering me the best deal? You talk about service fees and where they are today. We are told that fees are higher in the U.S. than they are here, but we cannot compare them. Where is the competition?
Mr. MacKay: We will provide a reference to the data we have so that you can look at it more closely.
We think, through time, technology will enable consumers to compare charges. Integrators are now determining what is being charged by particular institutions for particular products and making that information available on the Internet so that the customer who previously would have had to sort through 10 institutions and very complicated documents is able to utilize the service and comparison shop in a way that has never been possible before. That is one of the technological pluses.
Mr. Fred Gorbet, Executive Director, Task Force on the Future of the Canadian Financial Services Sector: Industry Canada has on its web site a facility that can be accessed by individuals who can specify the type of personal banking transaction that they use. They can shop that basket of all the major banks and trust companies on the Industry Canada web site.
Senator Hervieux-Payette: Have you tried it?
Mr. Gorbet: We used it for some of our research.
Senator Stewart: I have a genuinely elementary question. Earlier in the discussion, great emphasis was placed on the need for a greater opportunity for the entrepreneurial spirit in financial services. Senator Angus raised this matter most directly. Why should the financial services sector not be regarded in much the same way as, for example, the manufacturing sector? Mr. MacKay mentioned starting up a steel mill.
It is fundamental to almost all the recommendations you make in your report that we understand what you believe is meant by "public interest" in the financial services sector. Let me give you an example or two. I think we would all agree that the clearing system is a national service, just as the railway was in the earlier days of this country. Similarly, we would all agree that a mechanism that transfers money from those with savings to those who wish to use money productively is in the public interest. There has been a good deal of implicit understanding of "public interest" on the specific aspects of the financial services industry which are of public interest in the way that starting up a particular steel mill is not. That has been implicit in much of the discussion this morning, and I want Mr. MacKay to help us by making explicit what his task force assumed were the aspects of public interest which are served peculiarly by the financial services industry. It might help us if we have this either now or later as a guide as we wrestle with some of these questions involving the public interest of the financial services sector.
Mr. MacKay: I agree that one must think beyond the general term and try to understand, in the sector, what it is the community thinks is the public interest. In our exercise we wound up with what is found on pages 68 through 70 of our report, in which we describe what I mention in my opening statement as "our vision for the sector." We have said elsewhere in the report that it articulates our version of the public interest. It has three legs. It has a leg that begins to look at the characteristics of a sector that would be valued by consumers. That begins with our competitive sector and works through some of the elements of access to services and fair and responsible treatment. We then move to the structural features of a desirable system. We described a series of characteristics there, beginning with it being a fully open and competitive trading and investment environment. We then move to the regulatory side, where we deal with the types of regulatory features we would expect to see in such an ideal sector.
Having put that on one side -- and, our version of the public interest factors was overly lengthy, but we were unable to condense it more than we did -- we then looked at the concept in the context of mergers. We tehn proposed a public interest review process and articulated, again, six or seven important criteria that, in the public interest review process context, would come to the table.
Having said that, if you were to ask me if we have found the magic elixir of the public interest so that there is a touchstone that will give instant response, I must respond that I have not and we have not. However, we believe that the vision statement is a forceful presentation of a public interest.
Senator Stewart: I think you may have passed something in the night. When we speak about public interest, we seem to be conceding that there is such an interest in the financial services sector.
Mr. MacKay: Yes.
Senator Stewart: Could you tell us very briefly why the financial services sector should not simply be left to the forces of the market which we hear about so much these days? Adam Smith, by the way, in talking about international trade, said that that should not be a matter for governments; that it was a matter for providence. Now why should this not be left to providence?
Mr. MacKay: There are probably two ways to come at that. On the one hand, the sector takes and holds large sums of other people's money -- and that is completely unique and is very important -- with a promise to return.
In the second place, the traditional role of the utilization of those funds in the way you described in your preamble is the second point of distinction. If you add those two things together, you have something at work which is not even close to the steel mill.
Senator Stewart: Would you regard the investment by, let us say, a very large Canadian bank in a place like Russia or Indonesia as being in the public interest as you defined it just now?
Mr. MacKay: We are hoping that within the framework of the public interest in terms of the special factors as mentioned a moment ago and the vision we have of the sector, we can see world-class competitive companies. We believe they will be the companies who will finally be the most effective providers in our home market and lead to excellence of service at home.
Do we believe that throwing up a "Thou shalt not do business abroad" mandate would be consistent with the public interest? No, we would not think that.
The Chairman: How do you defend your opposition to commercial links, given the fact that there are other countries which allow financial institutions to have commercial links that are simply ring-fenced? The largest insurance company in Canada is owned by Power Corp., which clearly has commercial links. The largest trust company in Canada, Canada Trust, is owned by Imasco, which also has commercial links. Yet you are not recommending that either the Power Corp. case or the Imasco case be rolled back. How then do you defend the opposition to commercial links?
Mr. MacKay: Let us deal with the rollback. We do not recommend rolling back. That has its own life and we discussed it earlier. I should like someone on my staff to comment on your preamble. Our research shows that the largest banks in every country we examined are widely held and hence do not have commercial links. That is not to say there are no commercially linked institutions in those countries, but we have some material and I will refer you to it in a moment.
The Chairman: Let us clarify what we mean by commercial links. You could easily have a widely held institution that has commercial links. It would be very easy to envision a situation in which a widely held holding company owned a bank, for example, but also owned a car manufacturing company. Or you could consider a bank that owned the controlling interest in some kind of commercial enterprise. We ought to be absolutely precise about what we mean by "commercial links."
Mr. MacKay: Are you talking about downstream or upstream commercial links?
The Chairman: I am happy to talk about either.
Mr. MacKay: "Upstream" means it is on the shareholder side, in my lexicon. "Downstream" means activities that you are involved in.
The Chairman: You were proposing that there be no downstream or upstream commercial links. Is that correct?
Mr. MacKay: No. Let us talk about the upstream commercial links, which, in my mind, means "ownership." That was the thrust of all of my earlier discussion.
Regarding downstream commercial links, we are not proposing any change in the existing permitted range of activities where there can be some within the framework of specialized financing corporations and the other provisions of the current Bank Act.
Upstream, we are saying we would permit commercial links for small institutions. Downstream, we are saying we are not proposing changing the present commercial-links regime.
The Chairman: Except for minor situations then, links are essentially not allowed?
Mr. MacKay: I would have to get details but there is still a fairly big basket of permitted investment activities downstream. Beyond that, we do not propose to extend that.
Mr. Andrews: Just to elaborate on the upstream ownership restrictions, we provide some detail on that in Background Paper #2, around pages 19 and 20. As you go through that, you will see that the largest financial institutions around the world, be they banks or insurance companies, do tend to be widely held. In other words, commercial ownership links are not permitted.
The Chairman: We may want to come back to this at some other time, but when I look at GE Capital, which, as you described it, is clearly not a bank since it obviously happens to be foreign, it does, however, have a lot of commercial links.
When I look at Merrill Lynch, I wonder. You have circumscribed the definitions in a way that allows a lot of existing cases.
Clearly another Power Corp. could not emerge under your scenario and another Imasco could not emerge under your scenario. One wonders whether a Canadian GE Capital or a Canadian Merrill Lynch could emerge under your scenario? I wonder why we are blocking this? I do not understand the policy rationale when it is possible to protect the safety and soundness of the deposit-taking institutions.
Mr. MacKay: I do not know why a GE Capital could not arise under our recommendations. A new court has arisen. I do not think we have circumscribed things in the way you state. You may misapprehend here. Our effort is to open the system, not to close it.
The Chairman: I did not think you were closing it. I referred to this particular instance of commercial links. I agreed it was the status quo, but it was not being opened more.
I would turn now to your ownership provision. Let us take a concrete example, like Canada Trust, which is in your middle category. Its equity is around $3 billion.
If Canada Trust wanted to sell, it could sell to a widely held bank. It could sell to a widely held insurance Company like Manulife, for example, after de-mutualization. While you insist that various institutions be widely held, you also have a provision which says that any widely held, federally regulated institution can own up to 100 per cent of anyone else.
I am not necessarily sure that is the wrong policy. I am just trying to be sure I understand it. Does that lead to a situation where we are fundamentally affecting growth across pillars -- that is to say the purchase of major companies by the existing big players, whether they be the few banks or insurance companies that are above your $5 billion threshold? Are mergers and acquisitions across the pillars, in fact, encouraged by your report?
To that extent, Canada Trust, I presume, if it were to get the value of the control premium, would have to sell to another big player.
I am left with the feeling that you are really saying that many of the acquisitions must be made by the big players -- whether banks or insurance companies does not matter. Is that a fair conclusion?
Mr. MacKay: I do not think so. Canada Trust is not the best example because it is a grandfathered entity. It would then have available a system of grandfathered options. We have described those options in one of the papers. Not only would they include the ability to grow beyond $5 billion, which would be its entitlement, but we have provided that the grandfathered position of the controlling shareholder could be sold to another entity which would buy that position one time through. It refers to any entity subject to fit and proper consideration.
We have also suggested a safety-valve sale option to a widely held foreign financial institution for the Canada Trust-type companies so that their marketplace would not be restricted to just a few large Canadian buyers of whom you have spoken. Of that particular example, there are many.
The Chairman: They have a wider range of potential sale options because of grandfathering.
Mr. MacKay: Yes.
Dealing with institutions in that middle size, we are also anticipating that these may be institutions that want to make use of our holding-company regime and band together to form their own financial conglomerate. As you will have noticed, we recommended that the widely held banks, the smaller ones such the National Bank and Laurentian Bank, could voluntarily be recategorized back into the size-based regime they would be in by reason of their size as opposed to the fact that they are currently in the 10 per cent rule. That would permit them to find alliances and relationships that they are currently unable to find.
The Chairman: On page 94, you talk about the Hongkong Bank of Canada's proposal to broaden the Interac system so that deposits, not merely withdrawals, could be made. That is a great idea. Did you discuss that with Interac and, if so, what was the answer?
Mr. MacKay: No, we did not discuss it. It came late in the day, and we simply present it as you see it here.
The Chairman: On page 95, in the second-last paragraph, you say:
We have seen no evidence that markets have been seriously disrupted in these countries by bank distribution of insurance.
I simply tell you that this committee has, at least twice in the past, been in favour of banks being able to retail insurance, and we are delighted that you have that information. We did not have that exact comparative analysis, although that was our suspicion.
Similarly, on page 98, this committee has twice in the past been in favour of allowing banks to lease automobiles. I was quite fascinated by your comment about General Motors, where they talk about the decline in their business in the United States being attributable to competition and competitive pressures from banks in those markets where banks are into the leasing business. It is nice to see that; in fact, it has a benefit.
You raised in your opening remarks an issue that this committee looked at a while ago, which is the change in the accounting policy. Basically, you say that if you cannot get the Canadian Institute of Chartered Accountants to agree to the change, then OSFI should use its legislative authority to mandate the change. Again, this committee has been in favour of that.
Have you talked to OSFI and/or the Canadian Institute of Chartered Accountants, and where does that stand?
Mr. MacKay: We had quite a few discussions with the chartered accountants, CICA, and along the way with OSFI. My understanding is that OSFI has indicated its own wish to move in this direction if the CICA does not find a solution. It has on the table a menu of seven or eight possible options, with two or three preferred options. It is my understanding that CICA and OSFI continue in discussions to see if a solution can be found short of an OSFI prescription.
We did believe quite strongly that, absent something being put on the table that worked from the point of view of the CICA, OSFI should move, and I believe they are prepared to do so.
The Chairman: Thank you. Senators, that completes our morning session with Mr. MacKay and his colleagues. We will reconvene at 2:00 p.m.
The committee adjourned.