Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 6 - Evidence (Morning meeting)
OTTAWA, Tuesday, November 26, 2002
The Standing Senate Committee on Banking, Trade and Commerce met this day at 9:05 a.m. to study the public interest implications for large bank mergers.
Senator E. Leo Kolber (Chairman) in the Chair.
[English]
The Chairman: Honourable senators, we will resume our study on the public interest implications for large bank mergers. Our first witness is from Queen's University, Mr. Ted Neave, a professor of finance at their business school.
Mr. Edwin H. Neave, Professor of Finance, School of Business, Queen's University: Honourable senators, I have brief opening remarks. I should like to speak about the reasons behind financial mergers as I see them and some of the challenges that mergers create for management and regulators alike. Then I will try to summarize why, in my opinion, these mergers could be of net benefit to Canada.
We are seeing throughout the world, increased asset concentration and increasing convergence of formerly separate financial institutions. Both these trends are the result of mergers, some of which are purely domestic, some of which involve institutions from more than a single country. The economic forces driving this merger wave are technological change, the globalization of business, the resulting increases in competition and the widespread belief that large and well-capitalized firms have advantages in attracting international business.
Until fairly recently, high stock prices were a further contributor to this merger movement. Some analysts like to talk about lower regulatory barriers as another contributing factor to mergers. It seems that permissive changes in regulation are usually a response to industry initiatives, rather than a leader of those initiatives. Regulation can deter, but cannot usually prevent, changes in business activity that are based on sound economics. One example would be, despite the U.S. regulatory prohibition against interstate banking, U.S. banks did organize interstate operations through holding companies for many years prior to that prohibition being relaxed.
Mergers are really aimed at improving earning capabilities. They are aimed at capturing additional international business. They are intended to offer new domestic products and services and to find new ways of carrying out cross- selling if the merger involves related companies such as in the banking and the trust businesses, or in the banking and the insurance businesses. Mergers can also bring about savings in operating costs. They have the potential to realize economies of scope through cross-selling. They may be able to realize economies of scale in research and development and they may well realize economies of scale in consolidating computer and network operations as well.
Mergers do not just affect the level of earnings. They can also affect risk. There has been some research done in the United States, using hypothetical mergers of banks and insurance companies, operating companies that were hypothetically merged through a simulation, that shows that if you bring banks and life insurance companies together, there will be some cost savings through what are called ``economies of scope'' and there will also be a reduction of bankruptcy risk.
On the other hand, that same research shows that if you combine banking with the property and casualty insurance business, for example, there will be few or no cost savings through scope economies and there may be modest increases in bankruptcy risk. Other researchers, such as Santomero and Eckles, usually suggest that mergers will reduce operating risks, or at least not increase them.
The research studies just cited do not really ask about the nature of the firm's management; however, it seems to me that larger firms are more difficult to manage than their smaller counterparts. Unless management changes its practices to recognize this increase in size, then the newly created firm will not necessarily realize any improvement to earnings. On the other hand, one can imagine that innovative management might be able to create substantial improvements.
Turning now from the reasons to some of the performance issues that mergers raise, first of all, it seems important to recognize that increasing concentration implies increasing size, and that in turn leads to increasingly challenging management issues. In addition to this, when you combine businesses through convergence, that creates new interdependencies among the business units. That, too, increases the difficulty of managing the merged firms. This means that post-merger firms can be subject to an increased risk of operating losses, at least during the period management needs to acquire the skills to run this newly created company. These possibilities increase in importance if the combined firm conducts business in several countries.
Just to cite an example, when Citigroup was formed, one of the biggest tasks facing them was to integrate the back office of information and computing systems. Without going into a lot of particulars here, that task of integrating the back office in Citigroup is still going on. The merger began, as honourable senators will be aware, in late 1998, but the actual integration of the back office is still proceeding.
Mergers also present another kind of performance issue. It is possible that the anticipated growth that merger proponents suggest will not be realized as quickly as expected. This has been true, again, in the experience of Citigroup. The revenues have not grown as quickly as forecast, and neither has asset size.
If we turn from those management challenges to the regulatory issues, they look to me something like the following: As we have said before, concentration makes for larger intermediaries, and convergence not only makes them larger but more complicated. The increasing size and complexity lead to additional management challenges, as we have mentioned, and also to greater difficulty in supervising these operations, particularly in valuing the assets. In addition, complexity increases the difficulty of winding down a big institution. On the other hand, increased size and complexity may also contribute to this syndrome known as ``too big to fail,'' which may tend to offset the former effect.
The international banks' belief in the importance of mergers is currently being tested in another way. We are seeing that as these large international corporations take form and conduct business, they sometimes become embroiled in conflicts of interest. They may be embroiled in conflicts of interest with respect to underwriting and research in the securities business, or with respect to lending and securities underwriting in more traditional forms of banking.
Increased size and complexity require the regulators to increase their screening and monitoring activities of the industry. To cope with their bigger jobs, regulators may have to develop new tools and learn how to use them. This means that it is not clear whether the extra costs of enhanced supervision of these bigger firms will be offset by the fact that, after a merger, there is at least one less firm to be supervised individually. In addition, while the necessary regulatory learning is taking place, there is greater possibility for error of one type or another.
There is a question of whether increasing concentration and convergence create additional possibilities for systemic risk. Is the systemic risk of the financial system different as a result of these mergers? Unfortunately, it is difficult to give a clear-cut answer to this question. Probably the best answer is that we do not really know.
As management difficulties increase, there is a greater possibility of posting operating losses, and hence there is the probability that an individual firm will experience greater difficulty. In addition, with fewer institutions, the perception of contagion may be increased, and of course the interdependencies between businesses are also increased by the merger. On the other hand, there is this possibility that the merged institutions may be perceived as too big to fail, and therefore may be regarded as safer. Consequently, it is difficult to weigh these things.
I understand that the most relevant issue before this committee is whether the mergers will create net benefits for Canada. It seems that to address this issue, we should look at both the prospects for enhanced earnings and, in addition, any prospect of reduction in domestic competition. It appears that the principal benefits of the merger to Canada are the possibility of reduced operating costs, increased ability to operate internationally, and consequently greater earnings for Canada, enhanced possibilities for financing massive technological change, greater scope for some forms of cross-selling and, as a result, some possible improvements in customer service and quality.
On the cost side, one of the principal costs would be a possible reduction in competition, particularly in local markets, in addition to the losses that might result from the difficulties of managing the bigger and more complicated firms. To deal with the possible reductions in competition, it may sometimes be necessary to sell off a limited number of branches or perhaps a business line. Regulatory insistence on good management practice seems to offer the main possibility for offsetting losses from the merger-created management difficulties.
In closing, it seems that it must also be acknowledged that the Canadian public has been pretty unfavourable toward previous merger proposals, with the single exception of the TD-Canada Trust merger some time ago. The unfavourable perception seems at least partially attributable to the fact that the banks have not conducted the kind of public relations campaigns one imagines they might have. However, at the same time, it seems the Canadian public is relatively indifferent to the possibility that mergers will increase Canada's international competitiveness and foreign earnings. It seems that the Canadian public might be equally indifferent to the possibility that if Canadian financial institutions do not perform as well as those in the rest of the world, then the ultimate existence of our financial industry could be endangered.
Senator Tkachuk: My first question relates to a public interest concern. I come from the Prairies. The Royal Bank, along with the credit union, is the major lender to the agri-business industry in the Prairies. When mergers take place, do they abandon areas of business, or do they increase areas of business?
My concern is that once you get up to New York City and hang around with all the big boys, you might say, ``To heck with the farmer in the Prairies.'' It would be terrible for us to lose the expertise that the Royal Bank has gained working in agriculture, and they actually make money in the Prairies. However, it may not be as sexy as dealing with the Rockefellers.
Mr. Neave: I would think that bank management would be reluctant to abandon or de-emphasize any line where it was making money. I would hope that if agri-business were profitable for the Royal Bank, they would continue to be keenly interested in that. I do not see any reason why management as a whole should be distracted from a region simply because they are a bigger organization. They can create divisions that will look after that region.
I would acknowledge that sometimes, if divisions are created that are somehow limited in the types of lending that they can engage in, if they have to report back to head office, it might be a little harder for them to get their attention. I would rely primarily on your statement that, if the business is profitable, the banks will continue to be there.
Senator Tkachuk: Perhaps I should have phrased my question differently. Since the other banks have gotten out of the business of agriculture, my concern would be corporate culture. CIBC merges with Royal, as an example, the CIBC president becomes the president of the combined entity, and he is the one who led the attack in getting out of agriculture. I ask because you have studied this: what happens in those cases? What happens when mergers take place in other types of businesses? One of the players becomes the dominant corporate culture, and then what happens?
Mr. Neave: There usually is a dominant corporate culture. That dominant corporate culture will reflect the attitudes of the management that takes over the combined enterprise. Management's principal responsibility is to earn profits wherever this is legitimately possible. It would seem to me that, apart from personal preference, it would not be a well- informed management that would miss out on an area like this, so long as the profits were there to be earned.
I imagine it would be possible for some managements to suppose that a certain type of business did not fit into their corporate culture. In that case, they might want to sell it off. However, if they were to sell it off and it is a profit- making business, it should still survive. I do not think that the possibility of banks failing to concentrate on an area where they were earning money would be very great.
Senator Tkachuk: My second question relates to regulation, safety and soundness. Perhaps you would be able to enlighten us on how other countries, such as the Netherlands and Japan, have dealt with this. All of the banks that have come to discuss bank mergers talk about their ability to become a player on the international stage. Whether or not they are in the top 50 or 25 of the world seems to bother them. Some of them were, but are no longer.
When these banks merge and become international players, what kind of challenge does this present to our regulators? Also, if, for example, the Royal merged with CIBC, might the idea of ``too big to fail'' cause them to be somewhat indiscreet about how they do business, because of the expectation that someone will always bail them out? How have other regulators managed to handle the situation in their countries of their banks operating internationally?
Mr. Neave: I will try to answer this in three parts, in regard to the issue of size first, and then I will try to address the ``too big to fail'' question. I do not have a great deal of information about how regulators in other countries attempt to deal with this issue, but nevertheless, I shall try to address it briefly.
One of the reasons our bankers are so concerned with international expansion is that, domestically, they face what is largely a mature market. There is not much room for expansion within this market. The banks are generally over capacity in terms of branches in this market. If they want earnings to grow, they must look to other markets in order to find those growth opportunities. I do not believe they are concerned with international business simply as a matter of pride. They are concerned with international business in an attempt to continue to manage dynamic, growing corporations.
At the same time, they are concerned with keeping up with the rest of the world in terms of technology and the international markets they serve. In order to do that, they do need to be in the top 40 or so. If the banks fall too far behind, they will not be able to achieve the kinds of investments needed to operate in this modern financial world of ours. I suspect that some of these managements are genuinely concerned that, if they do not keep pace, they will fall behind and Canadian banking as a whole will become less important on the world scene. The driver behind this desire to increase size is that local markets are mature and the growing corporation needs to find others.
With respect to the ``too big to fail'' issue, that seems to be a legitimate concern. If we have very large banks, we will find it very difficult to let them fail if they should get into a great deal of trouble. The temptation to help them is likely to be there. It is acknowledged in the United States. I expect it has been acknowledged in Britain, as it has been here. Whenever that possibility exists, there is the possibility of moral hazard or that banks would not pay as much attention to risks as they would otherwise. In the final analysis, the only real recourse we have to manage this sort of thing is for regulators to take as tough an attitude as they can.
Paul Volcker was asked how he would handle the issue of moral hazard. He said, ``I will discuss that with your successor.'' Whether our regulators would be tempted to use that kind of language, I am not sure. However, the ``too big to fail'' issue is a real one. It requires tough-minded management. I do not believe we can avoid recognizing that.
As far as regulation in other countries is concerned, the main difference that we see today is the consolidation of all regulatory matters. For example, in Great Britain, securities, banking and all financial business is now under a single regulator. There are two regulators in Australia. That is close to what we have here. In the United States, regulation is highly fragmented and much needs to be done to attain the level of consolidation that exists in Britain, Australia or Canada.
Senator Kroft: While there is clearly a preference for having the option to merge, if they so choose, amongst the banks that we heard from yesterday, I believe it is fair to say that all of them, and certainly at least two of them specifically, said, ``Please understand, we will be okay whether we merge or not. What we really need is a clear direction on whether or not that is what government wants us to do, so that we can get on with our business effectively.''
Would you have any comment on that?
Mr. Neave: I think that the statement that they would continue to strive, if they are not permitted to merge, is realistic. It may be that in those cases, our banks would look to some form of partnership or other kind of alliance with foreign countries in order to do business in those countries.
I can sympathize with the view that it is easier if one knows what the rules are, because then one can formulate one's plans to carry out the domestic business within the rules and the international business in some other way, whereas if the rules were going to change, it might be possible to carry out those mergers.
Had I been in the shoes of one of those gentlemen yesterday, I might have said that it seems important to me that we be able to compete internationally within a regulatory environment comparable to those of other countries, like the United States and Britain, if we indeed want our banking industry to be one of the world's leaders, as it has been in the past.
Senator Kroft: One of the preoccupations of the government, going back through the MacKay report, and of this committee, was always the issue of competitiveness within the banking sector. One of the concerns with mergers, obviously, as you were discussing a moment ago, is whether or not, if you reduce the number of players, there will be less competition.
This then take takes us quickly to the question of alternate competition if, in the process of merging, banks are required to divest of branches, which provides an opportunity for other players, domestic or foreign, to acquire banking infrastructure, which would be more difficult or costly to do under other circumstances.
In that context, I would ask you to express your thoughts as to the extent to which foreign banks might be expected — I am not sure of your area of knowledge or expertise in this — to come in, fill some of the gaps and create new opportunities.
Mr. Neave: Yes. I have an acquaintance with this subject. I would not describe myself as an expert on it. However, I have studied Canada's banking industry for most of my career, and so I do have a sense of perspective on it.
With respect to competition subsequent to a merger, we can look to two possibilities. We can look to the domestic institutions, the credit unions and the caisses populaires, and we can then look outside the country to international institutions and ask whether they would bring additional competition.
However, before we look at those two things, I believe it might be appropriate to mention that reducing the number of large banks from, say, five to three may not have very much effect on domestic competition, except in certain local areas. Of course, if we were talking about a merger of two banks that were the only two in a certain locale, that would result in that becoming a one-bank locale, unless the competition authorities required a sell-off in that area.
However, for the most part, within the country, there is a degree of competition from the caisses populaires and credit unions. There is a degree of competition from institutions in other countries. That should mean that a merger would not seriously damage competition.
I myself do not feel particularly worried about the possibility of increases in prices if we were looking at a Canada with three major banks, say, a fringe of credit unions and caisses populaires and also the presence of banks from outside the country.
Now, do the credit unions and caisses populaires provide real and important competitive pressures on the banking system? I would be skeptical about this, except in these locales that we were talking about, because they have tended to take about the same percentage of the assets for many years now. It seems unlikely to me, even if we continued to relax the legislation that governs them, that they would suddenly become major players in the financial industry.
Now, what about the international competition? Under the North American Free Trade Agreement and pressures from the international community, I think that international competition will, if anything, get stiffer within this country. We will probably want to welcome that, because that will help to improve the performance of our local institutions.
At the same time, it seems to me we need to listen to the local institutions if they say, ``Well, we are facing increasing foreign competition. To meet this competition, we need to be bigger and tougher.'' If they tell us that, I believe it is incumbent upon us to listen carefully to that argument.
Senator Hervieux-Payette: Recently, we read in the newspaper about the profit of one of our large banks being the best in 10 years. What surprised me was that 60 per cent came from service fees from private customers.
When I am asked to look at the public interest, I start first with private people, then small business, then large corporations, then other sectors in banking and foreign revenues with activities outside of the country. These are the customers at large, and then we have the shareholders.
We have heard that Citicorp was not a great adventure for the shareholder. Have you seen other banks, because it is the banks we are looking at, that have really gained a lot by becoming bigger, and where the shareholder as well as the customer has benefited from the merger? Why merge if it does not produce any positive results? I would like to know if you have any kind of data or figures.
Mr. Neave: With respect to Citicorp, shareholder value was created to quite a substantial degree in 1998 when the merger first took place. Some of that value seemed to attenuate between 1998 and now, and that has been attributed in part to the fact that Citigroup incorporated a property and casualty insurance operation that they are now spinning off, and in part to management difficulties within the company. There were two heads vying for the job of CEO, and eventually it resulted in one of them leaving Citigroup, as you know.
To summarize, the formation of Citigroup created shareholder value. The extent to which that value was created and maintained probably did not meet the expectations of Citigroup at the time of the merger. That would be the first point.
The second point is with respect to consumer protection and consumer interests. There, I believe we would rely mainly on competition. Let us suppose that a merger does create cost savings. That is going to contribute, in part, to shareholder value, and it could contribute, in part, to consumer benefits, if they are passed on. The only policy mechanism we have to ensure that they are passed on is to make certain, as certain as we can, that the industry remains competitive. This would probably mean continuing to encourage those credit unions and caisses populaires, and further international competition within the country.
It does seem that, in many mergers, shareholder value can be created. This is certainly not a universal experience. It depends considerably on the details of the merger. It depends also to a considerable degree on the management of the merged company. If those elements are not there, neither shareholder value nor consumer benefits are assured.
Senator Hervieux-Payette: In your opinion, what would be the effect on very large developments in Canada? Let us say we need between $6 billion and $10 billion for Churchill Falls. We need $10 billion for the gas pipeline project in the North. Let us say that we have several large projects. Would there be a difference between the ability of merged banks to help finance these projects and that of a syndicate of a number of banks in this country?
Mr. Neave: A merged bank might have a better chance of becoming a syndicate leader. It may become a stronger competitor for the Morgan Stanleys, the Goldman Sachses and the other large investment companies. That kind of financing is likely to be international in scope, and our institutions will take part to the extent that they have good bargaining power and are seen as important on the international scene.
Senator Hervieux-Payette: Just to understand your answer, if we were to merge all of them to make one big bank, would they be big enough to compete with the bigger ones in the United States, the United Kingdom or the Netherlands?
Mr. Neave: No. When Canadian banks merge, they are not going to end up in the top 10. I have not actually done the calculation here; however, I do not believe that even if we assembled them all together into one big bank, that it would be one of the highest-ranked banks in the world. What probably is the case is that, if we permit our banks to merge, they will become stronger and better international players as a result; not the best, not the biggest, but they will be better and stronger.
That does mean that we bring more earnings home to Canada from other countries. It means that our domestic financial system remains, to a certain degree, within our hands. It further means that our domestic financial system can be relatively modern and up-to-date in terms of technological investment.
Permitting mergers will not cure all of our problems, but it may improve things.
Senator Oliver: You are an academic, and academics seem to favour the concept of mergers. In your paper, you gave six cogent reasons why mergers should be considered here in Canada. To refresh your memory, you said it would reduce operating costs, increase ability to compete internationally, increase earnings for Canada, and so on.
Mr. Neave: Yes, sir.
Senator Oliver: You went on to say that when bank mergers last came up, in 1998, Canadians did not look upon it favourably. There was certainly a strong reaction against it, not just politically, but from Canadians generally. You said that the banks did not have a very good public relations campaign.
As a result of the letter from Minister Manley, we are looking at the public interest impact assessment today.
One of the things that you did not discuss when you were listing your six reasons why mergers would favour us is some of the downsides. What about the transition? What about bank employees who will be laid off? What about downsizing and, most of all, what about access to capital in some of the smaller regions in Canada if things become centralized in Toronto? It seems to me that this committee should understand the impact on the smaller regions in the event of a merger.
Mr. Neave: With respect to downsizing, the other side of the coin of economies of scale and economies of scope is the reduction of the number of employees within particular parts of the banking sector.
Whether that would result in anything other than losses through attrition would depend on the extent to which that same bank was expanding its other forms of business.
Having said all of that, I believe it is likely. I think we have to take into account that when banks merge, one would expect a certain reduction in employment if the bank stays at the same size.
One would hope that the banks would be able to handle this delicately and humanely, through attrition rather wholesale layoffs. I believe we heard at least one of the CEOs yesterday addressing that question.
With respect to the local regions, our principal policy weapon to ensure that the local regions are looked after is to try to make sure that the system remains as competitive as possible.
If the system remains competitive, then wherever local regions present profit opportunities, one of the banks ought to be very interested in taking advantage of those.
I believe that the fear that going from six banks to three will reduce competition substantially is probably an exaggerated concern. However, I do understand very clearly that within the local districts, people will be concerned if they have one bank rather than two, and they will be concerned about their ability to get loans from that one bank, as opposed to three.
Senator Oliver: How can there be competition if, in Ontario and Atlantic Canada, there is no second tier provided through credit unions, as there is in Quebec and out West? How will those two regions be serviced?
Mr. Neave: There is some competition through foreign banks that will allow one to handle banking and loans by telephone. However, this remains a concern. I do not have a satisfactory answer for you.
Senator Oliver: What about access to capital in the regions? What about the tendency to have everything concentrated in Toronto, on Bay Street? What happens to the outlying regions of Canada?
Mr. Neave: Let us talk about access to capital in two ways. If they are large business projects, that type of financing has to be arranged with some reference to the major centres in the country anyway. If we are talking about local businesses, then it seems to me the best we can do, in the event of a merger that will reduce the number of banking outlets in a locale, is to ask one of the merging units to sell off that branch to a credit union or another institution to try to preserve the local competition.
I believe you had another part to the question, but I have lost it now.
Senator Oliver: That is not always the case. Last night, TD-Canada Trust told us that when they were ordered to divest some of their branches, virtually no one wanted to pick them up. The customers at the particular Canada Trust branches wanted them to keep them, but the bank had been ordered to get rid of them and no one was interested in picking them up. A number were sold at fire sales and then closed. How is that in the public interest?
Mr. Neave: That is not in the public interest. However, we have to take account of the fact that, on the whole, that merger may have been in the public interest, notwithstanding the fact that certain locales bore these negative effects. It is regrettable that we cannot offset some of those local negative effects. However, we do have to look at the overall impact of this business decision. If the overall impact of the decision is creating benefits for the country, then it seems to me the best we can do is to try to manage these difficulties of which you speak.
Senator Tkachuk: Banks in Canada are widely held. It seems to me that all five of them are talking about the merger process, the need for increased capitalization and to be international players.
The reason they are only considering merging with Canadian banks is because only Canadian banks are widely held. It seems to me what is going to happen is that four out of the five could merge, leaving one on the outside. Where does that one go, considering the widely held provision? They will go to one of the two, because they will have difficulty dealing with an American bank, which may be larger and therefore more difficult to merge with. It makes it an impossible task.
Do you think we should get rid of that? Why do we have that provision anyway, apart from of all of the good stuff about keeping Canadian banks Canadian?
Mr. Neave: The principal reason is to prevent a bank from falling into the hands of a small business group that may then use depositors' money primarily for its own interest. It seems to me that, as a general matter, one would want a large bank to be widely held just so that the financing that they do is allocated to many different business opportunities across the country rather than being concentrated.
Senator Tkachuk: Is the Mellon Bank in the States widely held?
Mr. Neave: I do not know.
Senator Tkachuk: I do not believe it is. What about the Chase? It is widely held; however, they do have someone controlling the bank. By ``widely held,'' I mean that no one is allowed to own more than 10 per cent. We have a 20 per cent provision now.
Mr. Neave: We may wish to consider allowing that limit to increase over time. That 20 per cent may not be the kind of limit that we want to stick with in the next 10 years or so. I am really not ready to discuss the pros and cons of that issue this morning.
Senator Tkachuk: I thought I would ask.
The Chairman: Senator Tkachuk, I do not know the answer to your question, but you may remember that when Bob Campeau, the real estate businessman, was buying up Royal Trust, they were worried he was going to use their money for mortgages or something.
Senator Tkachuk: Right.
The Chairman: Everyone zeroed in on it, and it was a tough time. I do not know the answer.
I would like your opinion on something. There is a school of thought that says, and I do not know if it is right or wrong, that if we do not allow mergers, then within 10 years, and some say five, our banking system will be totally irrelevant globally; that because of NAFTA and global pressures, we will have to allow foreign banks in; that the Canadian banking system will probably end up in the control of foreigners; that Canadian companies wanting to do business in other parts of the world will have trouble getting financing from Canadian banks because they will not be big enough — that is already happening, by the way — and that Canada will lose a lot of its economic sovereignty, plus jobs and a whole raft of things. Do you find any truth in that statement?
Mr. Neave: Yes, sir. That is a possible scenario. That is what we are hearing from the executives of these banking corporations. They are saying that they need to be bigger and stronger in order to compete within the context of these international developments of which you just spoke.
The Chairman: My experience in business was that many great Canadian corporations, including some with which I was involved, even in the real estate business, quickly came to the realization that the Canadian market, as wonderful as it is, is really very small on a world scale.
Mr. Neave: Yes.
The Chairman: Even in real estate, we had to go to Houston, Dallas, Los Angeles and Atlanta to keep our people busy and our investment on track. That was true. Seagram was started — it does not exist any more, but be that as it may — in Canada and ended up with less than 3 per cent of its sales here. I do not know if that applies to banks or not. It is certainly something to think about. In the meantime, thank you for being with us. We appreciate your remarks, and we will keep you apprised of what we do or do not do.
The Chairman: Thank you very much. The next group of witnesses will be from CS CO-OP, Gary Seveny, José Gallant and Madeleine Brillant.
Mr. Gary Seveny, President and Chief Executive Officer, CS CO-OP: Honourable chairman and senators, I thank you for inviting us to appear before you this morning to present CS CO-OP's views on the public interest in Canadian bank mergers. We believe it is essential that the meaning of ``public interest'' be as clearly understood as possible. An efficient, competitive financial sector is the backbone of a successful modern economy, and it is imperative that the process for considering bank mergers be transparent and accountable.
We have provided you with a written submission, which I trust each of you have received in advance of our appearance today. This morning, I will summarize the key points we make in our submission. My colleagues and I would then be pleased to respond to any questions.
CS CO-OP offers a somewhat unique perspective on the issue of bank mergers. We are both a customer of two major Canadian banks and a competitor of all the banks in the provision of financial products and services to Canadians. My remarks this morning address both of these perspectives.
Let me begin first by talking about our relationship with big banks as a customer. CS CO-OP is large by credit union standards but small when compared to the assets and capitalization of the five big banks. Due to the differences in our relative size, we often rely on the size and scale efficiencies of Canadian banks to provide products and services that we could not offer to our members on our own.
For example, CS CO-OP and our wholly-owned bank subsidiary, CS Alterna Bank, use one of the big five Canadian banks as a direct clearer in the clearing and settlement of payment transactions with our members. This is a vitally important service, and is of such magnitude that it requires more resources than CS CO-OP and similarly sized financial institutions can bring to bear. We mentioned other arrangements we have with one or more banks in our submission.
The key point is that in assessing the public interest impact of a bank merger, it is imperative that consideration be given to business clients as well as the retail customers. While the impact of a particular bank merger proposal cannot be foreseen and must be judged on its own merits, it is possible that the merger of two or more of Canada's largest banks could translate into lower costs for smaller financial institutions that purchase services from them in order to meet the needs of their own customers. Lower costs flowing through to a bank customer such as CS CO-OP would enable us to keep costs to our own customers as low as possible, continuing to make us an attractive competitive proposition. In our view, such a result would be in the public interest.
Let us look at the other side of the coin, which is CS CO-OP as a competitor to major banks. From this perspective, we see at least two important public interest considerations: the increasing importance of size and scale as a key determinant of competitive success, and growth opportunities for us and other competitors. As a competitor of the major banks, we understand the desirability of building greater size and scale. Size and scale are important in a business that is becoming increasingly ``commoditized.'' In fact, the drive to achieve greater size and scale is an important contributing factor in the rapid consolidation of Canada's credit union system, one of the most significant developments in our community over the past decade.
One of the reasons for increasing size and scale is to build the capacity to invest in the expensive new technologies that Canadians have come to expect from us and from our competitors.
Canadians understand and want the benefits of accessing bank services at any time of day, seven days a week.
I can tell honourable senators from firsthand experience that running several electronic networks while simultaneously maintaining a branch distribution system is an expensive proposition. Building size and scale is also essential to competing effectively in the Canadian financial services marketplace against foreign companies. Large multinational competitors such as ING Direct, MBNA, Citibank, GE Capital and others enjoy the market and scale capacity to be formidable competitors to all financial institutions, large and small. There is little doubt that size and scale will continue to be an important issue for the Canadian financial sector in the future. In this regard, credit unions face competitive pressures similar to those being felt by the big Canadian banks. Ensuring that Canadian financial institutions have sufficient size and scale to compete in an increasingly North American and global market is an important public interest consideration.
Looking now at potential growth opportunities emerging from a big bank merger, we think that we are well positioned to attain additional customers and acquire assets.
With regard to the first, some customers of the newly merged bank may well want to move their business to a credit union. We believe that credit unions offer more personal service at the local community level, an attractive proposition for bank customers worried about becoming lost in a much larger institution. CS CO-OP would welcome disaffected bank customers.
Opportunities for us to acquire branches or other business operations from merging banks might also arise. The Competition Bureau may determine that a proposed bank merger would be anti-competitive, but conclude that those anti-competitive aspects are capable of being remedied by the sale of certain assets.
The recent merger of TD Bank and Canada Trust illustrates this point, with branches in three markets being sold, and Canada Trust's MasterCard portfolio being purchased by a foreign bank competitor. The potential interest and capability of the credit union system to participate in such new business opportunities should not be underestimated. Although it was not in a merger context, the Manitoba, Saskatchewan and Alberta credit union systems acquired 48 branches from the Bank of Montreal in 2000. We believe it would be in the public interest to consider how bank mergers might help strengthen competitors in the financial services marketplace.
A relevant consideration in any merger review is the state of the competitive alternatives in the marketplace. It is also important to look ahead and forecast potential future developments that could affect competition. When analyzing the potential impact of a big bank merger, government policies aimed at meeting the public interest by increasing competition in the financial services sector should be considered.
One of the forward-looking policy initiatives currently being studied by Finance Canada is the possible creation of a new type of bank in Canada, a cooperative bank. CS CO-OP strongly supports this initiative. We have provided a detailed written submission to the Department of Finance.
I know that the Standing Senate Committee on Banking, Trade and Commerce has had a strong interest in developing competition in the financial services market, including the cooperative sector. In raising the issue of cooperative banks, we are not suggesting that any future merger be prohibited; rather, our interests are twofold. First, it illustrates our point that bank merger analysis requires consideration of future developments. Second, we want to keep honourable senators informed of this important matter, given your committee's interest in strengthening the cooperative sector and offering a broader array of competitive choices for Canadians.
In conclusion, it is our view that the public interest should be considered in its broadest possible sense. I do not pretend that we have exhaustively reviewed every factor that might be included in a public interest test. I imagine honourable senators will receive considerable input on that question over the course of this week. However, we suggest that you consider the following four points: First, the possibility of lower costs resulting from size and scale efficiencies, which business customers of a bank may be able to pass on to their own customers. Second, the desirability of enabling Canadian financial institutions to compete more effectively in what is becoming a North American and, indeed, a global market for financial services. Third, the prospect of growth opportunities for competitors by obtaining bank customers and acquiring bank assets. Fourth, the potential for new government policies such as permitting cooperative banks to affect the future state of competition in the financial services marketplace.
We at CS CO-OP believe the bank mergers do not by definition necessarily harm customers and competitors. We are both, and we recognize that the particular circumstances of a bank merger proposal may yield benefits to customers and competitors. I hope we have offered compelling reasons why a broader review of the public interest in the case of future bank mergers is warranted.
Senator Setlakwe: The witness who preceded you said that maturing markets was one of the reasons why the banks were interested in mergers. If I heard you correctly, Mr. Seveny, you seem to suggest that if the banks do merge, there will be greater opportunities for you to acquire bank branches and assets. The competition would still be diminished, because they would no longer be players in the local markets. You would be enhanced because you would be acquiring assets and branches and customers, but the competition would not increase. Am I right in assuming that?
Mr. Seveny: Your analogy is good. Using the purchase of Bank of Montreal branches in the Prairie provinces as an example, the credit unions did not have an existing branch in many of these Prairie towns. It was an opportunity for them to enter the marketplace with an established book of business. Likewise, a comment was made earlier that the credit union system is a second-tier player and does not have enough breadth across the country to be a true competitor.
Senator Setlakwe: Except in Quebec.
Mr. Seveny: B.C. has a very successful system as well. There are certainly pockets that need to be filled. The acquisition of locations that banks occupy is an option. I also mentioned disaffected clients of banks. We believe that Canadians love to hate their banks. Public opinion shows that, and yet they seem to love their credit unions. Why are they not coming over in hordes to the credit unions? I am not sure that these disaffected customers would make a move to the degree that we might hope. However, we would welcome them in the credit union industry.
Senator Setlakwe: Provided that you gave the same services that the banks are now giving, which are not satisfying those customers?
Mr. Seveny: I should mention that credit unions have full services now. We compete on almost every service front with the major financial institutions. Yes, we are known for having a higher level of service compared to the banks. Hopefully, that is a bonus for those clients who are displaced.
The Chairman: Do you happen to know if there is a credit union in Thetford Mines?
Mr. Seveny: There is, yes.
The Chairman: Senator Setlakwe comes from there.
Senator Setlakwe: My concern is if the banks close shop and we only have five caisses populaires in Thetford Mines, will we be getting competitive service? My answer is no.
Mr. Seveny: There is another point, which is the degree of market share that caisses populaires enjoy in Quebec.
I would say that the caisses populaires have a greater market share than the major chartered banks. I do not mean against all of the banks, but individually. They have done an extremely good job of building market share, so they are the true competition.
Senator Setlakwe: They have. However, if the local banks disappear and the caisse populaires, or the credit unions in Western Canada, have a monopoly on banking services, to what extent will the consumer be well served?
Mr. Seveny: Thank you. We were talking about ``widely held'' earlier. Our organization is extremely widely held. Every client is a member. Would we want to irritate our clients through poor service and charging increasing fees or rates? From a competitive perspective, our service is a commodity when it comes to the pricing. The pricing will stay low if we can deliver it in a low-pricing formula. That was one of the points here. A merger would potentially deliver lower costs to us, so we can then keep our costs lower.
A credit union or a caisse populaire does not have the profit motivation that shareholder wealth has to be considered. We make our argument for caisses and credit unions on the basis that we would continue to always be competitive, even if we were the sole party in a community. That is often the case, by the way. There are many communities where the only financial institution is a credit union.
Senator Setlakwe: Guided by your altruism.
Mr. Seveny: Yes.
Senator Kelleher: I wish to move partly away for a moment from bank mergers. At the time the Bank Act was amended, certainly merger talks were in the air. The government wanted to create what they called a ``third tier'' in Canada. They wanted to make it easier for ``new banks'' to come on the scene and provide more competition. For example, they eased somewhat the restrictions on the entry and capital requirements for international banks — ``foreign'' banks, as they have been called. They also permitted the so-called ``American model'' of community banks.
The other area that they looked to with the most hope was credit unions. They really hoped that maybe somehow, the credit unions could get together and create new banking systems within their existing operations.
At least in my opinion, and I think to some extent the opinion of the government, these hopes have not been realized. There has been some progress, but it is not significant. Could you tell us, assuming I am correct — if I am wrong, please also explain — what is happening with credit unions in attempting to fill this gap? It does not seem to have been realized.
Mr. Seveny: Senator, you are correct. We can start there. When the government entertained the discussions, the Senate committee was very helpful in ensuring that those discussions progressed to the Department of Finance and to Parliament. The credit unions had an interest in pulling together to form what we call a ``cooperative bank'' or a ``community cooperative bank.'' However, time was not adequate to pull it all together. When the federal government was running out of time in developing legislation, we were taken off the agenda with a promise that they would come back to the credit union system by way of a discussion paper. That discussion paper was released this April.
We have had 14 responses to that discussion paper. The credit union system was encouraged to respond individually and through their centrals. We are not able to speak on behalf of all credit unions, obviously. We are headquartered here in Ottawa. We have branches throughout Ontario, and we formed a bank because of that easing of regulations. We established CS Alterna Bank so that we could serve our clients who live across the river in Hull. That bank was to give us a national presence as we decide to move further. However, we want that to be a cooperative bank.
The green paper that came out received a lot of response from people who support the philosophy of a cooperative bank. Will it develop into legislation? We continue to encourage the Department of Finance to do that. One of our major plans is to change our small bank into a cooperative bank, so that we might put CS CO-OP and the bank together as one entity, owned by our members.
Why did credit unions not work together across Canada? Honourable senators must remember we are highly democratic organizations. Each credit union requires the support of its members. We must have legislation before us that says that we can ask our members to vote on the issue. We have not yet had that opportunity. Federal legislation has not been developed. We cannot ask our members to vote to combine with other credit unions or become a cooperative bank. That is one of the reasons it fell apart.
Another reason was that the timing was too compressed to get the absolute commitment for which the government was looking. We are continuing that charge independently, hoping that taking a leadership role in this process will cause others to wish to do the same thing. In fact, two other credit unions, to our knowledge, are applying to open a bank subsidiary for the very same purposes that we did.
Senator Kelleher: Do you feel you are getting adequate support, if I can put it that way, from the Department of Finance in this area? Is there some impetus or push you need? Is there something our committee could do to support this if we had a brief from you in that regard?
Mr. Seveny: We would be happy to enlist your committee. We believe that we are getting adequate support from the Department of Finance. Other parties on the outside who are aware of the support that we are getting tell me that it is a good level of support. As president and CEO of an organization, it is not enough and it is taking too long. If I could enlist your help, I would certainly take advantage of that.
Senator Tkachuk: Did we not talk about this in the previous round of discussions?
Mr. Seveny: We did.
Senator Tkachuk: Did the Department of Finance officials not say that they would get on with this matter and that it was very important? It is three years later.
Mr. Seveny: That is correct. They lost time in that in the first round in regard to Bill C-38, Parliament dissolved. The time in between was spent fixing up some of the drafting that they had done on the major banks, insurance companies and Canadian Payments Association. We still did not get airtime. When the proposed legislation was revived as Bill C- 8, they realized they were in a time crunch. They promised us that, although setting us aside, they would not forget us and we would be dealt with before the next round on the Bank Act. The Bank Act round is coming up soon, and we would like to get some exclusive attention before that round arrives, when we would again become a flea amongst the giants.
Ms. Madeleine Brillant, Manager, Corporate Growth, CS CO-OP: Honourable senators, I would add to Mr. Seveny's comment from the perspective of where we stand currently with the Department of Finance. We are encouraged because of the discussion paper on cooperative banking that they issued in April 2002. The process is ongoing. They have received, as Mr. Seveny mentioned, a number of submissions, all supportive, in principle, of co-op banking. We are encouraged to see that. We certainly welcome the second step, which will be a report to be developed and submitted by Finance Canada on the results of these submissions.
Senator Kroft: On page 3 of your report, you mentioned, although not in a merger context, that the Manitoba, Saskatchewan and Alberta credit union systems acquired 48 branches from the Bank of Montreal. Would you indicate the circumstances of that? Was that just branches that the Bank of Montreal had decided did not fit well with their operations? Was there anything more than the obvious in that? The second part of my question is, is it your sense that, in those provinces, and also in Ontario or elsewhere, that there would be a continuing appetite for those kinds of opportunities?
Mr. Seveny: We were not a direct player in the acquisition of those branches in the Prairie provinces in 2000. However, we were aware of what was happening. The Bank of Montreal had determined that the size of its business in certain communities was not adequate to continue to support servicing those clients as the Bank of Montreal. Thus, they put those branches and clients up for sale. The credit union system acquired those branches and clients.
Similarly, Bank of Montreal was looking to divest in Ontario. We were approached, but we, too, could not see the business case for some of these branches. They were branches from which they had utilized all the capital. They were worn-out branches. From a wealth perspective, the locations were pretty good. They were aging populations, so there was a significant amount of money per client. However, there was not a balanced book of business from which we could make a business case. They were pretty mature communities with one-sided balance sheets, which is why the bank was looking to sell them. They never did sell them; they maintain them still. Out West, the same thing was done for the same reasons.
Senator Kroft: Is there an ongoing appetite in the credit union movement for the acquisition of viable branches?
Mr. Seveny: There is. It is important to return to some comments that have been made about our industry, not just by Canadians, but by outside observers. We are probably an over-banked country. There are more bank branches in our country per population than anywhere else. We have enjoyed a few good opportunities here in Canada to take advantage of the strength of the major banks by forming networks that are now cooperatively owned. The Interac network is one such cooperative.
If there are more bank branches than can be sustained by our population in some communities, is there a way of connecting services between branches? I can think of many reasons why the Competition Bureau might have some issues with that. It is something we in the credit union system do effectively. We provide interbranch servicing, which is helpful.
The Chairman: Thank you for your presentation today.
Senators, we are very pleased to have with us Paul Bedbrook, President and Chief Executive Officer, and Andrew D. Ross, Director of Communications, for ING DIRECT. Welcome, gentlemen.
Mr. Paul Bedbrook, President and Chief Executive Officer, ING Bank of Canada: Thank you, senator.
The Chairman: We are happy to have with you with us. Do you have an opening statement?
Mr. Bedbrook: We do. Thank you, honourable senators, for giving us an opportunity to present here today as a foreign subsidiary. As a large international conglomerate, we can bring a perspective that I am sure the senators are interested in.
With me today is Mr. Andrew Ross, the director of communications, who helped to put together our submission.
Also in the audience here is a non-executive director of ING Bank of Canada, Michael Bell, former Canadian ambassador to the Netherlands. That Dutch connection led to his connection with ING. Michael is also a resident of Ottawa.
Reading the newspapers this morning, I see that a number of these issues are already on the table. It is not my intention to read our submission, which you have, but really to go through each point briefly. It appears that the committee is looking at the process of mergers. The public interest, how that is decided, determined and clarified, appears to be the issue. We will certainly comment on that.
Nonetheless, our submission does go through a number of the issues related to mergers in addition to the public interest issues.
I should say at the outset that ING would clearly not have a direct interest in the mergers, given that we are talking about the large banks here in Canada. Clearly ING DIRECT, having started only in April 1997, is not about to do a merger itself.
Nonetheless, the first comment I would make before I get on to the submission is that honourable senators should be aware that the mergers would be beneficial to competition in Canada in the short term. It would benefit us in the short term, as well as other competitors, such as the co-ops that were here before, the credit unions and others.
Nonetheless, in the long term, it would probably count against us, given that the banks would be larger, stronger and, we would argue, more efficient and better international competitors. I believe that senators should be aware of that. We see no threat to ourselves from the mergers.
As I said, it is not my intention to go through each point of our submission, but rather to speak to each point, then to the public interest issues.
Along the way, hopefully the fact that we are a large foreign conglomerate and the issues relating to that will come out.
Firstly, I refer to page 3 of our submission on ING DIRECT. ING Bank of Canada is doing extremely well. We now have over 600,000 customers in Canada. We have over $8.5 billion in deposits. So far this year, we have over $3 billion in new deposits, second only to Bank of Montreal for growth of deposits in Canada this year. We feel that you can be competitive in this market and grow. As I repeat, we are not really threatened by mergers. I should state at the outset that we are really for the mergers, as you can read at the start of our submission. The facts about ING DIRECT and how we are doing are there on page 3 for you to read.
The point I would make here is that we are part of the ING global group, itself the result of many mergers. It was formed in 1991 by the merger of NNB Postbank, which was itself the result of the merger of two banks in Holland, with the largest life insurance company in the country. ING is the dominant player in Holland, having roughly a 25 per cent market share in retail banking and insurance. Many other mergers and acquisitions have happened along the way.
We are a global example of an institution that has got to the top 20 internationally through mergers and acquisitions, and we would argue the resulting economies and efficiency that can result from that. Hence, ING was able to experiment with ING DIRECT here in Canada. It was the first location for ING DIRECT back in 1997, which we would argue strongly has been in the public interest of Canadians, in the sense that what we offer, we believe, is generally better than the equivalent product here in Canada. I believe that that size and those economies and what have you have led us to do things outside of Holland, obviously, and here in Canada specifically, and now in six other countries. We would not have been able to do that without achieving a particular size. Clearly that has benefited the public here, as well as, if you like, back in Holland. ING itself, like Unilever and Royal Dutch Shell, is a leading institution in the Dutch environment and a flagship of that economy, and perhaps that is partly what we are talking about here. Can a financial institution be created that can lead the Canadian financial sector in a way that is beneficial globally and locally?
Perhaps I will just quickly go through the points that we make starting on page 5. Some of these are to do with the international side, but many of them are just straight microeconomics. Firstly, there is excess capacity. I believe I heard the previous speaker talking about that. There are too many bank branches, too many ATMs, too many staff and too many services in the banking community. Most people, apart from special-needs groups and particular geographic locations, have more banking services than they require.
As an example of that, we used to have a network of about 230 bank machines. We have just got out of that bank machine business. Frankly, they did not really pay, and there was already roughly one bank machine on every major intersection in all the major cities. We have offered our clients access to every bank machine in Canada. We felt that we did not need that infrastructure because there were already too many ABMs. The economics of ABMs is deteriorating over time, as most bankers would know. That is an example. We make the point in our submission that there is excess capacity, and this leads to inefficiencies, creating a larger infrastructure than is necessary, and a higher cost structure, which the public ends up paying for through bank fees and what have you.
The second point we make is that the mergers will allow for greater efficiencies and greater economies of scale. I have already said that ING benefits globally from its own economies of scale. We are like the other banks in a microcosm, in the sense that we have a certain fixed cost structure. As we grow, the same cost structure basically can service the customers and what we do. The merger of two of the larger banks would, over time, although not initially, create economies of scale and a lower cost structure per customer, per account, per dollar, in the bank. In the long run, that should be good for customers.
The third point is one that I think was being discussed just prior to ING DIRECT appearing here. Mergers, we believe, may encourage niche competition and more competition. If there were three big banks instead of the current five, I am sure some of those banks would not service particular locations. I am sure they would drop certain inefficient products. There are certain things they would not do. That is part of the concern. I can assure you there are a number of alternate players, including us, who would step in and fill those niches. In fact, it would create opportunities for players.
You may be able to tell from my distinguished voice that I originally come from Sidney, Australia. Down there, the banks used to worry that everybody else could offer every product that they offered and they would just be pecked away at by all the niche players and the best-of-breed players who would offer one product. You would have a mortgage specialist outdoing the banks on mortgages, a mutual fund manager who was better than the banks, and a specific deposit taker. I could see that happening if there were fewer but very large banks. They would be slow. Smaller players would be more nimble. It would create opportunities for those who are entrepreneurial and quick. We certainly see it. The banks cannot move as fast as we can. There is no question about that. Senators should not think that it would necessarily crush competition. You may be surprised and see niche competition developing and some new players. There are certainly many foreign banks here in Canada already. Often they just service particular communities. However, if these mergers were to happen and opportunities came about, you may see them expand.
That is the third point. It might be counter-intuitive, but I believe it has been shown in other countries, and I look to the U.K. There is a lot of competition from niche players and specialists in the U.K. as well.
The fourth point is the one that most of the big banks are making: Mergers will allow Canadian banks to better compete internationally. There is no doubt about that. Size does matter when you are competing globally. When you are trying to be a lead underwriter of major issues and what have you in financial markets, it does make a difference. It is because ING is so large that it is able to do what it is doing in Canada. ING have now invested up to half a billion dollars in capital in Canada to support their business, and clearly, we are right behind what we are doing in the long run. Canadian banks, if they are large, can clearly do more of that and compete more effectively on the North American stage at the outset, and perhaps beyond. I believe the issues surrounding that have been well documented by the CEOs of the larger banks.
The fifth issue we have on our list here is the impact on service levels and access to financial products. It is generally thought that it would be negative if there were fewer banks. We would argue that that is not necessarily the case. I believe that people are dealing with financial services differently than they used to. There are alternatives there. There are the credit unions; there is us; there is HSBC; there is AMEX; there is President's Choice Financial. There are a number of players. In fact, we are surprised. That should be growing faster, we believe. It could be growing faster. Nonetheless, there are alternative players to fill those niches. I do not think it is necessarily the number of players that determines access to financial products and service levels. It is more the way that banking is being done going forward.
That sort of intersects with our sixth point: Financial consumers have moved on. Time has moved on. If we look back 20 years, or even since ING DIRECT started in Canada, the world has changed. I believe there were statistics quoted yesterday by the majors that 90 or 95 per cent, depending on the bank, of day-to-day banking transactions are done electronically. Clearly, we are a virtual bank, without branches, so apart from cheques we receive in the mail, everything is electronic. People have now accepted this. The bankers association says that over 55 per cent bank regularly via an ABM or over the Internet.
We disagree that people are still as concerned as they were about physical service. Times have changed. There are certain special groups with needs, certain geographic locations and what have you. The reality is that I do not believe that people are as concerned about these issues as they were even five years ago. They now understand self-service banking. They realize it is, easier, more efficient, cheaper and gives them better service.
Not everyone has moved on. We still have customers who only send us cheques in the mail, who only come to our so-called ``information centres'' and insist on talking to someone. There will always be that group, but the vast majority of Canadians realize that the game has changed.
From a public interest point of view, the public sentiment is different now compared to five years ago. There is no doubt in my mind. We can all think of how we love to queue up at branches and that sort of thing. We do not do it anymore, unless we want to have a long chat or something like that.
The other point we would make, before I move to the specific public interest issues, is that mergers are important, but the key issue is to ensure that a competitive environment exists for all players. Hence, there is a better choice and higher value for consumers.
If we create an oligopoly of three big banks that dominate the world and we make it difficult for new players, who must go through hurdles and the processes that we went through over four years, crawling and begging for the benefits that the major players already have, then we are not creating an even playing field. It must be easy for people to start up small, niche operations and compete effectively.
Mergers are one thing, but OFSI, the Competition Bureau and so forth, control the public interest. They could make it easier to have more competition. Therefore, what would be good for the consumer is not necessarily related to the number of banks. It would be beneficial to create an environment that enables the entrepreneurial spirit to thrive.
Before I wrap up, I will speak to the specific public interest issues that were listed. In regard to access for Canadians throughout the country to convenient and quality financial services, we would argue that due to technology improvements, access to banking services is now of a higher quality and more convenient than before. Perhaps that is an issue of making fast Internet connections and PCs available to remote locations and to people who do not have them now. Clearly, we have been ranked highly on service standards, which we see as ironic, because we were the no- frills bank that was not meant to give service. If you want service and a relationship, go to another bank; do not come to ING DIRECT, because we just offer great value and what have you. However, when service rankings are done in the industry, we rank quite highly. We ranked highly amongst individuals who know about money. What they say about us is that our organization works — it is convenient, good value and fast.
People view services differently from the, ``Oh, I want to see someone face-to-face and walk in there and talk about it,'' and that sort of thing. People see the meaning of ``service'' changing to speed, accuracy and ease. It is much easier to sit in my lounge doing my banking than it is to walk down the street and queue up. That is how people are seeing it.
In regard to the second point, the availability of financing for individuals and businesses, particularly small and mid-sized businesses, my background is in money management. This is clearly a function of the capital cycle, not of how many banks are out there. If people are finding it tough to obtain financing now, that is a function of the business cycle generally, not of how many large banks or banks generally are out there. We all know that that is really what happens. We do not believe mergers would have an impact on that issue. Banks are generally trying their best and really want to lend money to small businesses. It is the business cases of those small businesses that do not always stack up. That is a difficult thing for people to accept.
In regard to the third point, this is not a major impact on the Canadian economy and the ability of Canadian business to compete internationally. Currently, in a certain micro sense, there will be an impact on certain locations and some rationalization of staff. If this were a question of the viability of the banking sector changing, then clearly it would. The banking sector is a pillar of the Canadian economy and one of the reasons Canada has such a stable economy. However, that is not in question at all with the mergers. Our view is that ability to participate in international competition would not affect the Canadian economy at all and is not a major variable in the long-term benefit.
In regard to competing globally and any benefits that might have, in order to have a global player with a head office here in Canada, size does matter, and clearly that would be a benefit. Having a major global financial services operation based in Canada is a good thing. That is a positive, and for that reason mergers should happen.
Turning to the subject of communities and bank employees, there is no doubt that there would be some rationalization, fewer bank employees, and things like that. However, I believe that many industries have undergone these sorts of rationalizations. They are part of the maturing of a business. It could be argued now that subsidization is going on because mergers are being prevented. The natural process for the major banks would be for them to merge. That is a fact. Specific communities should be accommodated, but that becomes an issue of what subsidization is occurring. We make that point.
In conclusion, ING DIRECT supports big bank mergers for all the reasons that I have stated in the submission. There is currently a healthy environment outside the big five. We find this a good place to do business, and we will continue to see that as the case, whether or not there are mergers. We do not feel threatened by that.
Thank you for the opportunity to speak to this committee. I end here and await questions and discussion.
Senator Angus: Thank you for coming back to the Banking Committee, and for your usual cogent and persuasive presentation.
Mr. Bedbrook, in regard to getting out of the bank machine business, you say that you have offered your clients access to every bank machine in Canada. I understand how that works, but could you explain the pros and cons of having your own machines out there, and how you give access to the machines of other banks?
Mr. Bedbrook: Every customer receives a card with which they can withdraw cash from a bank machine. We will pay the 75-cent Interac fee when they use their card. They used to use it at our machine, which was free; now that does not exist. We now say that they can go to any bank machine and we pay the Interac fee. There are banks that only charge the Interac fee. That makes the transaction free.
Senator Angus: How does that work? When clients receive their statement, does it show the $50 coming out, with a charge for the fee, and then a credit on the other side of the statement?
Mr. Bedbrook: The statement does reflect something like that, yes. We only pay for the 75-cent fee. There are surcharges on some bank machines and other machines; we do not pay those. Clearly, we are still offering a great deal. Offering that to all our customers and paying the 75-cent fee is one-sixth of the cost to run the network.
Senator Angus: You mentioned that Internet banking is cheaper for the consumer. Could you explain why that is, apart from the fact that they do not have to go down to the bank?
Mr. Bedbrook: We know that the cost of an Internet connection is marginal. You are using a network that does not have the same cost as walking into a branch, which has the physical infrastructure, plus a teller, a person. Those are the two extremes.
Senator Angus: I understand it is more expensive for the bank to maintain the branch, but what about the consumers, considering they like to take a little walk down to one of the four banks on the corner?
Mr. Bedbrook: Then you get into different issues. Some people like to physically visit us and you cannot stop that. We are saying only that the cost of the transaction is less. The marginal costs for us are less. Therefore, the marginal costs to the client should be less as well.
Senator Angus: As reflected in what?
Mr. Bedbrook: If it is not, then the bank is subsidizing one channel with another.
Senator Angus: How is it reflected? I do not want to get bogged down in the details. If I am a customer, you tell me it is cheaper. I bank on the Internet and somewhere down the line I will see that reflected in what way?
Mr. Bedbrook: Clearly, a branch is more expensive than an ABM machine, which is more expensive than a debit card, a credit card and so on. There is no question. If you use your debit card or your normal bank card at an ABM machine, you could be charged a fee. If you make a transaction on the Internet, it will cost you nothing.
Senator Angus: I believe ING was represented when we held hearings in 1998.
Mr. Bedbrook: I was not here in 1998.
Senator Angus: You have been here at other times.
Mr. Bedbrook: Last year, yes.
Senator Angus: In listening to your presentation this morning, I got the sense that there have been fairly significant changes in the relevant landscape since 1998. Am I correct?
Mr. Bedbrook: Absolutely.
Senator Angus: In terms of the issues, all of which I believe you touched on in one way or another, the climate and the environment are much more conducive and favourable to a merger now. Is that right?
Mr. Bedbrook: In 1997 and 1998, when we launched, Internet banking was a novelty. The Internet itself was still almost a novelty. Telephone banking was still relatively new and it is now mainstream. That is the main switch. People have realized that paying bills online and all those sorts of things is the way to move forward. Over 50 per cent are already doing that. It is just a matter of time before a large majority do that. That is the main thing.
We see that the branches of the major banks are different now from what they used to be; they are wealth management centres, or a place to use your ABM. They are designed differently. They are trying to create major banking centres. They are not trying to do everything, like they used to. We all know that that is a major infrastructure cost for them that they would rather not have because of the economics that I talked about.
Senator Angus: From an objective point of view, is it not correct to say that ING, at this stage of its life and in the scheme of things, would benefit if two or four of the big banks merged? That would assist ING, would it not?
Mr. Bedbrook: That question was put to us when Canada Trust merged with TD. Yes, there was some flow of customers to us, as there is always some dissatisfaction arising out of a merger. It is absolutely not the primary reason that we are successful in Canada.
I admitted upfront that all smaller competitors would benefit from a merger in the short term, because there always is dissatisfaction and disaffection at the time that the merger happens. However, in the long run, those will be bigger, uglier, better competitors than we currently face, and that is bad for us.
Senator Angus: Generally speaking, you favour mergers?
Mr. Bedbrook: Yes.
Senator Angus: As a matter of public policy in Canada, and as an issue affecting the integrity and competitive nature of our financial system, you are in favour of bank mergers, and you would, marginally at least, if not more, tend to benefit from bank mergers?
Mr. Bedbrook: I do not think more than marginally. We would benefit in the short term, and I mean that 18-month transition period. Beyond that, it starts working against us. There is no doubt about that. However, standing inside or outside ING, we think the mergers are appropriate for Canada.
Senator Angus: Now, you mentioned global competitiveness four times in your report, and you concluded with:
In conclusion, ING DIRECT supports the ability of Canada's big banks to merge. Mergers would help, (but clearly not guarantee), Canada's banks, to successfully compete on the global stage.
Nearly all of the proponents of mergers, particularly from the big five, are saying the same thing. I was reflecting on it last night after the hearings. What will they be able to do? Can you provide us with some specific, concrete examples of things that they cannot do now, and how Canadian enterprises would be better off as a result of mergers?
Mr. Bedbrook: I could say you should ask them, because we will not be doing that.
Senator Angus: You know what I am saying.
Mr. Bedbrook: Yes, I do.
Senator Angus: It is more persuasive coming from you. I feel you are very articulate. You have said that we will be able to compete. I would like some concrete examples.
Mr. Bedbrook: There are two things, and one is the investment banking world and the world of mergers and acquisitions and that sort of thing. There is no doubt that size matters, and you cannot be a leader in those sorts of games unless you are one of the big 20 in the world. That is more the wholesale end.
Senator Angus: The big 20? You have to get that big, do you? We might as well put all five of them together.
Mr. Bedbrook: Or the big 50. Let us look at other things, such as importing ideas from overseas. We are an idea imported from Holland to Canada by a Dutch company. Within the ING network, we import and export ideas around the world as part of that financial group. Those benefits flow back here to customers. Likewise, I believe that if Canadian banks were larger and international players, they would import ideas from overseas and that would benefit customers here. That would clearly be the case at the retail end.
Senator Angus: We were given an example by the CIBC, if I am not mistaken, that involved your own organization in terms of getting into electronic commerce in the United States. They have been at it for three-plus years. They indicated they have closed it down. They were not making any money.
They referred to an announcement from ING that you have been in it for six-plus years and are only just turning the corner and starting to get into the black. They used this as an example of how being large gives you the clout and the staying power to do innovative things like this. Would that be an example of what you are talking about, or is that something different?
Mr. Bedbrook: That is an example from which ING has learned. However, it is really more a question of execution.
I believe that the way CIBC executed their decision is the real issue here, not that we are big and powerful and can stay the course. CIBC is wealthy enough to stay the course longer than they have.
Senator Angus: They do not need a merger to be able to do that?
Mr. Bedbrook: No, I do not believe so.
Senator Angus: It is just a matter of this being a priority.
Mr. Bedbrook: We clearly have return-on-equity targets that we have to meet for our head office in Amsterdam. Next year, we will meet all of those targets. This year will be our second year of profit; next year will be our third year. It is more a question of execution. I will leave it at that.
Senator Kroft: Mr. Bedbrook, can you tell me about ING elsewhere in the world? You are ING DIRECT and you are a virtual bank. You are out there in cyberspace. Are you real anywhere?
Mr. Bedbrook: In the eyes of the regulator, we are. They see us regularly and ensure that we exist.
Do you mean within Canada?
Senator Kroft: No, I mean elsewhere. Do you operate in other countries?
Mr. Bedbrook: Yes, we do. In Holland, there are traditional banking operations. There is the Postbank, owned by ING, which is the old post office network in Holland, and that is clearly a large branch network. They do not have a so-called ``virtual'' bank in Holland. They already have that other presence. That would be cannibalizing their existing business. ING is familiar with both.
ING has a large retail network in Poland; Bank Slanski is the major bank there and they are still building branches. In Poland, branch networks are the way to grow your bank. That is something that is happening in many of the Eastern bloc countries, whereas the concept of ING DIRECT only works in mature, well-developed countries.
Senator Kroft: What interests me, in terms of one of the preoccupations of this committee is, if two banks come together in a merger, and that results in some rationalization or reduction of traditional service in some areas, or a reallocation of resources, who will make up that difference? Your commitment to this country is totally on the virtual concept. Is there any way in which you might move into a brick-and-mortar type of presence?
Mr. Bedbrook: One should never say ``never.'' However, in the short term, our strategy is the virtual concept, which makes us low cost. We are a low-cost operator, which is why we can compete. We focus more on savings and less on loans. That is our competitive advantage.
ING has the largest insurance operation in Canada. That is a larger business than ING DIRECT, even though the ING DIRECT brand is better known.
Globally, ING is an integrated financial services concept. In the long run, that is what we want to establish in developed countries. If we look to the next five years, I cannot see ING DIRECT changing, other than offering more products and what have you. In the very long run, ING Group is about integrated financial services. That is the whole range of financial services in developed countries.
I would not count it out, but I would not say it would happen in the short term.
Senator Kroft: My next question has to do with the opening line of your last response. It has to do with your regulator. In your view, does the degree to which you are so far-flung globally and so diversified create any problem for your regulators in Holland? To put it simply, do they have any trouble keeping track of everything you are up to?
Mr. Bedbrook: Unfortunately, no, they do not have any difficulty keeping up with what we do. We have the local regulator here who governs us. We also have the Dutch regulator who governs the holding company in Holland. Two regulators govern the bank here in Canada, plus we have all our head office requirements, because the Dutch, as we all know, are the Scots of Europe, and are more conservative than most people.
The answer is no, they have no trouble keeping up. They keep close tabs on what ING DIRECT and ING Bank are doing globally.
Senator Kroft: What about the various requirements of your prudential obligations in terms of capital base, exposure and so on?
Mr. Bedbrook: We must meet both requirements. Generally, the OSFI requirements are more conservative.
Senator Kroft: Does the Dutch regulator recognize OSFI? We have asked this question at another time. However, I am wondering whether OSFI is recognized and accepted by your regulator as a relief of their regulatory burden.
Mr. Bedbrook: There is no relief of the burden because of OSFI. It is now acknowledged, although initially it was not. It was a start-up and they did not know about it. Also, it was a brand-new concept. Over time, clearly, they are more reassured by the presence of the Dutch regulator than other countries that we could think of.
Senator Kroft: I assume that the Dutch regulator takes some level of comfort from the OSFI involvement.
Mr. Bedbrook: Yes, it is implicit. It is not spelled out explicitly.
Senator Oliver: The reason we are here today is to consider a minor aspect of bank mergers, that is, their public interest impact and the role of this and other parliamentary committees on that subject. That is what my questions will be about. You addressed it today on page 9 of your presentation. I do not agree with you when you say that the availability of financing for individuals and businesses, particularly small and mid-sized businesses, will not change if there is a bank merger.
As a result of some statistics we saw last night, we know now that two of the big five are already losing market share in that area. It is our opinion that if there were mergers, and more things were concentrated in Toronto and not in the regions of Canada, then that would be even more difficult. I disagree strongly with what you say about it merely being a market cycle. I think it would also be a factor in the concentration of power.
Mr. Bedbrook: If we are talking about the concentration of the larger banks in major cities and away from the regions, and it therefore being harder for small business in those regions, then the credit unions, or other, smaller banks, would fill that vacuum. When that happened in Australia most became east coast banks or east coast financial institutions. Perth and Adelaide were not involved. The local players filled those niches and you started to see viable little institutions in each of those smaller locations. I assume the same thing would happen here.
Senator Oliver: In terms of a public interest strategy to ensure that that will happen, are you recommending that this committee or other committees look at putting conditions on the merger? Would you say it would just happen naturally?
Mr. Bedbrook: I would probably say it would happen through market forces. I do not believe I am the person to recommend conditions on that happening. We heard the previous speaker saying that they would only be too happy to buy networks. HSBC has said they would be happy to buy branch networks. It could be a condition that, in a particular location, that branch network is sold to another, more local player, or an international player like us who is happy to use that as an entry strategy.
Senator Oliver: You have stressed that you are a virtual bank, yet you have 600 employees. What do those 600 virtual employees do?
Mr. Bedbrook: There are 250-plus in a call centre. Although we are virtual, we still do a fair bit of banking through people calling a teller or associate on the phone. That is a big area. Bank office operation accounts for about 100 people. We are virtual, but we still go through the same processes as normal banks. Some of that, dare I admit it, is not entirely automated or electronic behind the scenes. We still need people to open the mail and do those sorts of things. The next largest area is, of course, the IT, which is actually running the platform.
Senator Oliver: One of the things that some of the big five have discovered as a way of enhancing earnings is to concentrate more on so-called ``wealth management.'' Is ING involved in that? Is it possible for a virtual bank to become actively involved in wealth management?
Mr. Bedbrook: We would like to be more involved in wealth management. It is a difficult market. It is a mature market here in Canada, which makes it difficult to break into. Also, the current environment is difficult. We market mutual funds directly to the public. Again, it is a question of execution. When you are a direct marketer, the product cannot be too complex.
Much of wealth management is about offering advice and talking to people and having complex products that can satisfy needs and what have you. We have had limited success in that because our marketing is direct. We do not have an advisory network, which is where 95 per cent of the wealth management business is in Canada.
Senator Oliver: If you want to grow your earnings, certainly that is one of the areas you will have to take a good look at, is it not?
Mr. Bedbrook: It is. That is consistent with the ING global strategy.
Senator Tkachuk: One of our concerns over the last couple of days has been that if there are bank mergers, then we need competition. What can the federal government and the regulators do to make it easier for foreign banks to gain access to the Canadian marketplace? We all talk about it. However, CS CO-OP has been working on a bank franchise for years. It is a slow process. What can we do to make this process safe but speedier?
Mr. Bedbrook: The first thing is the perennial subject that, dare I say, we whine about, which is the capital tax issue. ING is very conscious of that. ING DIRECT of Canada is always compared to all ING operations elsewhere, and we are more expensive partly because of that capital tax. That can only be a disincentive.
It is the same with the process of mergers. People want transparency. They want to know what the process is and what hurdles they have to jump over. They have it all lined up. They get their act together and come to present everything and they know it will be accepted because they have gone through the process.
In our experience in those initial years, it was not always transparent. We did not know quite what we had to do to get the 20-times multiple on capital, because we started at 14.5 and were therefore, we felt, at a disadvantage.
Anyone coming in wants to have the regulatory process clarified.
The second point would be size-appropriate reporting. We have 600 staff. A not insignificant number of them, somewhere between five and ten, answer to all the regulatory requirements and spend their time talking to OSFI and all the others, although not so much now because we are far more experienced. However, in the early days, we would hire lawyers to get us up to speed. Perhaps size-appropriate reporting would be a factor. An example is a limited institution licensed only for deposit-taking or some specific aspect of banking. That is why this is such a global issue. More competition is wanted. It would be preferable to have one federal regulatory system for all financial services, not the provincial system combined with the federal system.
There is a federal system for banking. Wealth management is a pain for us because we must be licensed in every province. That is expensive. Although we are virtual company, we must have an actual person in each province to sell mutual funds in that location. Those are clear examples as to why we are not jumping on the bandwagon here.
Senator Tkachuk: Let us say the federal government finally clarifies things and decides that it wants to do this. At the same time, with regard to these other issues, especially wealth management, getting the provinces together will probably not happen in our lifetime. Certainly there are other things we can do to make the process easier and quicker. Perhaps we as a committee should be demanding that happen at the same time.
Mr. Bedbrook: Ideally that is what would happen. However, this is not an ideal world. I am not waiting for it. I have zero expectations about it myself.
Senator Tkachuk: You have been around government for a long time.
Mr. Bedbrook: We have a good relationship with everyone.
Senator Hervieux-Payette: First, I should like to tell your communications people that they have excellent ads on television. Your gentleman is very convincing. I will wait to see the woman who will be as convincing.
Mr. Bedbrook: There are three women.
Senator Hervieux-Payette: I know the one who wears a special suit.
Senator Tkachuk: She wants to see all women, I think.
Senator Hervieux-Payette: I want to see equality.
Let us say that we have found a perfect formula and we know that the public interest is protected and so on. You have extensive experience in your operations abroad and you feel that it would be a good step for Canada to move in that direction. A merger is one thing, but acquisition is another. You want to grow, and there will be more money if you put the two together; 100 plus 100 will make 200. We would like 100 plus 100 to make 300 at the end of the day; otherwise there is no need to do it.
When you carried out these acquisitions in Canada, how did you finance your operation? Half a billion dollars is a lot of money.
Mr. Bedbrook: That was financed by the parent company. They wrote a cheque to capitalize the organization. As we have grown and the regulator has required us to have capital to meet the size of the bank, they have continued to write cheques. There is free equity, which is ordinary shares, and there is now subordinated debt.
Senator Hervieux-Payette: Was there a special public offering?
Mr. Bedbrook: No. ING is a publicly listed company in Amsterdam and New York. We are 100 per cent owned by that publicly listed company.
Senator Hervieux-Payette: How many large banks are there in the Netherlands?
Mr. Bedbrook: There are only a couple. They have gone through that rationalization process. The Dutch have accepted that they will only have a few banks.
Senator Hervieux-Payette: You have two large banks.
Mr. Bedbrook: Yes. There is ING Bank and ABN-Amro.
Senator Hervieux-Payette: One of the issues in mergers is the private customers and small business. Are your customers mostly private individuals, small businesses, or large companies?
Mr. Bedbrook: We have about 600,000 customers. They are all private individuals. We do have business savings accounts. Thus, business or private individuals, sole traders and proprietary companies do make deposits with us. We have found that servicing small business means doing a specific thing for them, which is what they do want. They are one sector that does want a more hands-on service. There is no question. Most of our customers are individuals.
Senator Hervieux-Payette: Your ads were very good.
Mr. Bedbrook: Thank you. They do their work, and generally, more women than men like them.
Senator Hervieux-Payette: I believe it is important to see who has switched from one service to another.
What would be the percentage use of ATMs, telephone and the Internet?
Mr. Bedbrook: Over 50 per cent of our transactions are Internet-based. Telephone banking is about 20 per cent. About 10 or 15 per cent is people actually phoning and talking to someone. Then there is ABM and point of sale.
Senator Angus: You mentioned, Mr. Bedbrook, that there are two big banks in Holland. Is not Rabobank another big bank?
Mr. Bedbrook: Rabobank as well, I am sorry. That is correct.
Senator Angus: So there are basically three.
Mr. Bedbrook: Yes. There are three.
The Chairman: Thank you for being with us. We have enjoyed your presentation.
Mr. Bedbrook: Thank you.
The committee adjourned.