Robert Macintosh, Former President, The Canadian Bankers' Association
Introduction: John F. Bankes
President, The Empire Club of Canada
"To write books is easy, it requires only pen and ink and the ever-patient paper. To print books is a little more difficult, because genius so often rejoices in illegible handwriting. To read books is more difficult still, because of the tendency to go to sleep. But the most difficult task of all that a mortal man can embark on is to sell a book."
From a poem by Felix Dahn, paraphrased by Sir Stanley Unwin.
Coming up with the right title for a book--the magic combination of words that will turn browsers into buyers--is a blend of art and inexact science, the mastery of which is crucial to the success of a book. Understanding the importance of an intriguing title for his book, a young first-time author hesitantly approached Somerset Maugham for aid in coming up with a title for his opus:
"Any drums in the book?" asked Maugham. "No." "Any trumpets?" "Uh-Uh."
"Then call it No Drums, No Trumpets."
Our guest speaker today, Bob Macintosh, has written a book about drums--Different Drummers, to be precise.
Like its author, Different Drummers is a little bit of everything: "a mixture of history, journalism, argumentation--and personal reflections." Bob Macintosh's principal objective in Different Drummers is to take his readers on "a short tour around the playing field of banking and politics, showing how the various teams march to the beat of different drums."
Dr. Macintosh's text is rich in history, anecdote and understanding of the somewhat blinkered world of Canadian banking. Rather than review or critique his book, however, I would prefer to set the stage for Bob Macintosh's remarks today. The theme of his remarks is that the structure and business powers of commercial banks reflect the social and political environment of the day. The regulatory climate impacting on banks, however, often lags a long way behind reality. This nation's banks, according to Bob Macintosh, receive about as much respect as a fire hydrant gets from a poodle!
This message is particularly timely and important in this era of uncertainty and change involving financial institutions in Canada and abroad. Let me briefly cite several examples:
First, recent disclosures concerning Bank of Credit and Commerce International--or BCCI--portray a bank that took money from more than a million depositors around the world and--in what has been described as a planetary Ponzi scheme--became a personal piggy bank for its Arab and Pakistani owners and its favoured customers.
Second, U.S. regulators are still wrapping up after, and coping with, the fall-out from the thrift industry's meltdown resulting, in part, from credit indiscretions involving commercial real estate, below investment-grade bonds and Latin American governments.
Finally, America's banks, like jilted lovers, are increasingly seeking solace in each other's arms. Within the space of a few weeks this summer, three massive bank mergers have been announced. Assuming for a moment that big really is better, where does that leave Canadian banks?
The British economist and journalist Walter Bagehot once commented: "The business of banking ought to be simple. If it's hard, something is wrong." In light of the above complex issues and experiences, it is worth asking: When did banking stop being simple?
This fall, Canada is scheduled to embark upon the next chapter in the Federal Government's agenda to reform the legislative and regulatory framework governing the country's financial services industry. Accordingly, it's worth examining these recent issues and experiences in detail. And our guest speaker, Bob Macintosh, is a worthy commentator on this process.
Armed with three university degrees, Dr. Macintosh joined the Bank of Nova Scotia in 1953. His mother was not impressed with this career choice.
"Robert, why are you throwing away your education?"
She could hardly bring herself to mention it to the neighbours. In those days, Bob points out in his book, people with university degrees did not go into banking. Nevertheless, Bob had a rewarding 27 years at the Bank where he supervised the Bank's investments, as well as taking responsibility for the computer division, law, economics, mortgages and management training.
John Kenneth Galbraith once said: "Banking may well be a career from which no man really recovers." Bob is an apparent exception to this theory. In 1980, he was appointed as the first full-time President of the Canadian Bankers' Association, a position he held for 10 years.
Both as a banker and as the bankers' spokesperson, Dr. Macintosh has built a reputation for independent thinking and straight talk. Ladies and gentlemen, please welcome Bob Macintosh.
Mr. President, ladies and gentlemen. I was quite astonished--but nevertheless, pleased--to receive an invitation to speak to you today. I feel like the Roman general, Lucius Cincinnatus, who was called back from the plough to help defend the Imperial City once more against the invading barbarians. In this analogy, I will leave it to you to judge who the barbarians are. I notice a few of them in the audience today.
Anyhow, I guess the invitation is to recognize the publication of my book on banking and politics in Canada, Different Drummers. These remarks are an extension of some issues discussed in the book and, of course, do not necessarily represent the views of the CBA or the banks, for whom I do not speak now.
Having worked around the corner of King and Bay for almost 40 years, I know the parents of the current crop of executives better than I know them. Your President, John Bankes, might be seen as an exception to this phenomenon. John was the elected student representative on the Board of Governors of York University when I was Chairman of the Board, so I have known him a very long time. But, as it turns out, I have known his father even longer. Jack Bankes was a highly regarded executive of the Royal Bank who is still active in the business community.
I have not mentioned either of them in my book, which does not deal much in personalities. This will disappoint those who think that a book about banking and politics should be heavily loaded with muck-raking and gossip. Different Drummers is more about issues than about people; but there are almost 1,000 names in the index, so I guess it is not entirely free of personalities.
The newspapers have already noted that the book is not kind to some distinguished Toronto citizens of about three generations back. If you are not aware that Casa Loma is the ultimate monument to real estate speculation in Toronto, then you will find that Different Drummers does get into personalities sometimes.
But the chapter on the connection between Casa Loma and the Home Bank is not intended to be just a narrative about the last bank failure before the two Western bank failures in the 1980s. It is a story about using other peoples' money for the personal enrichment of a few financial buccaneers.
The public outcry eventually forced the politicians to do something about it, and there were significant reforms to banking legislation. However, governments do not learn very quickly from experience, because the same sort of things have been repeated in our time in more than a dozen small trust companies. Eventually, the regulatory environment catches up with reality, but we seem to have to learn the lessons all over again.
The current worldwide eruption of concern about the BCCI is a very good example of regulatory lag. To say that the financial system has become globalized is a cliché. With foreign exchange markets, which are largely free of control in the industrialized world, and with instant telecommunications, huge amounts of capital can migrate to the major currencies in most parts of the world in moments. This is why international standards have been applied to the large international banks throughout the OECD.
The rules of the so-called Basle Concordat require, among other things, that each member country must enforce agreed standards of capital adequacy on its own banking institutions. But it has seemed to me for some years that there was a significant loophole within the European Community in applying international standards to banking regulation.
Luxembourg is a member of the European Community, of the OECD, and of the Basle Concordat on the standardization of banking regulation in Europe. The European Community has been inclined to treat Luxembourg as a full sovereign power, comparable to its neighbours Belgium and Germany. This may be appropriate for purposes of European trade, but it is hardly acceptable for international banking standards.
Luxembourg has a population of about 370,000. There are about 180 banks and 6,000 holding companies. There is no central bank in Luxzembourg, and its own domestic currency is administered on its behalf by the central Bank of Belgium. There is a financial regulatory authority, but its record in the matter of the BCCI speaks for itself. It would seem that the fairest way to describe Luxembourg is a country of convenience, like Panama and Liberia in the shipping industry.
Apparently it has been convenient to the other members of the European Community to tolerate this situation. It is a little difficult to understand how it could be tolerated for so long, because it provides an opportunity for anyone to establish a head office for a bank which then has access to all the other members in the OECD across the globe.
As Professor Richard Dale wrote in 1988:
"Luxembourg is renowned for its tough bank secrecy laws--In effect, complete secrecy prevails; and it should now be obvious to all--that secrecy attracts criminality."
Our own Canadian regulators relied on the Bank of England and the Luxembourg authorities, according to their own declaration, to assure adequate banking standards. This was perhaps an unfortunate oversight, since the Government of Luxembourg banking regulations specifically do not apply to holding companies which the BCCI topmost company was.
As for the Bank of England, it never did provide full banking status to the BCCI, but classified it as a "deposit taking institution." This was in fact the cause of my original concern, voiced informally in 1982, about the BCCI being licensed in Canada, coupled with the fact that the Federal Reserve Board would not allow its entry as a national bank in the United States. Recently, a former U.S. comptroller of the currency and onetime Superintendent of the New York State banking system, John Heimann, noted that he rejected an application for a banking licence into New York State by associates of the BCCI, because there was "no primary regulator." The Bank of England was in no position to supervise the worldwide operations of the BCCI because the London operation was only a branch and in any event could not assert sovereign authority over a bank headquartered elsewhere.
To make matters even more dicey, there was a separate BCCI holding company headquartered in the Cayman Islands. No overall regulator should accept the notion that a parallel headquarters could exist elsewhere and out of reach.
The Canadian authorities as well as the Bank of England chose to overlook these little problems, for reasons which I do not understand. Granting access to Canada, and indeed to the whole international banking world, to a bank or bank holding company which has no primary regulator is clearly an invitation to disaster, and a worldwide disaster we have had. The real issue on the table is to define clearly that the right of access to banking in Canada must be restricted to banking institutions which are themselves properly regulated in their home jurisdiction.
Again quoting Dale (in July of this year): "the (BCCI) structure makes a nonsense of the Basle Concordat which was revised in 1983 to take account of the principle that banking supervisory authorities cannot be fully satisfied about the soundness of individual banks unless they can examine the totality of each bank's business worldwide."
When the Bank Act was amended in 1980 to admit foreign banks, this obvious constraint was implicit in the legislation and was set out explicitly in the guidelines attached to the Act. We admitted about 60 foreign bank subsidiaries in 1981-82, and in every case except one the parent was a properly regulated foreign bank, subject to the central bank and the supervisory authorities in its home jurisdiction.
The BCCI was the only exception I know of, and that is why I challenged it at the time, noting the attitude of the Federal Reserve and the Bank of England. The revelations of the bank's behaviour should not deflect attention from the real issue, which is the conditions under which foreign banks are admitted to Canada
As it happens, this very question is examined in Different Drummers in the chapter on the politics of foreign banks. But the context is somewhat different. In 1983, we had a huge battle with the government over the admission of American Express to Canada I want to be quite clear that there is nothing in common between the BCCI and the American Express Bank, and they cannot really be discussed in the same sentence except to say this: There is no regulated parent bank of American Express Bank of Canada Its parent is a travel company, and the parent is not subject to the Basle Agreement on capital adequacy or indeed any other international banking standards.
The parent is not a member of the Federal Reserve System, and is not regulated like all the other 16 American banks which have subsidiaries in Canada As the book points out, the government ignored its own guidelines in granting access to AMEX. The Minister of State (Finance), Mr. Loiselle, said that guidelines were just that, and could be ignored when appropriate--I would like to see the reaction if a bank ignored the guidelines. The book describes how the Canadian Bankers' Association lost that battle, one of the many which I lost over a period of 10 years.
But to compound the problem, the draft banking legislation which is now in the works builds this very sloppy approach right into the legislation. The government can decide that other financial institutions, loosely defined, can be recognized as the parents of Canadian bank subsidiaries. This could include all sorts of American corporations which are not regulated banks in the United States, where we can daily observe the workings of the American financial system as it builds ever larger losses for depositors and taxpayers.
But our legislation is not of course applicable only to the United States. If the Minister of Finance sees fit, he could grant recognition to any financial service organization on any sand dune country in the world which happens to suit the government of the day. The government can decide when it gets up in the morning that American Express travel service is a financial institution but General Electric Capital Corporation is not. It can decide that a largely unregulated bank based in Luxembourg is a suitable parent for a Canadian subsidiary, but that one based in the Cayman Islands is not--at least for the moment. This is not a coherent policy about the admission of foreign banks to Canada, and this is the lesson which should be learned from the BCCI affair.
Warning Flags Mean Extinction
On a happier note, the Canadian Superintendent of Financial Institutions, Michael Mackenzie, deserves credit for quietly putting the clamps on the BCCI in Canada. The bank had been reduced in size by more than 50 per cent in the past year. Mr. Mackenzie had caused the capital of the bank to be significantly increased, and had closely monitored the quality of assets. As it turns out, he had put the bank on a three-month licence, and then on a monthly licence. There has been some criticism that this fact should have been made public.
But it is hard to see how the regulator could make his concerns public without causing an instant run on the bank The very fact of announcing that a deposit taking institution is on a short-term lease would cause an instant run on the institution and it would have to close its doors at once.
In such a case, the large uninsured depositors take their money and run, leaving the insured deposits to be covered by the least liquid assets and any shortfall to be paid for out of the deposit insurance fund. We had several trust company failures in which this very thing happened. The irony is that the very people whom the law is not meant to protect are the ones who get out first and scot-free. Clearly the regulator is in a double bind, no matter what he does.
I do not have an answer for this problem, except to note that it emphasizes the need for a comprehensive early warning system which will tell the regulator that an early clampdown is needed. One element in a gradual clampdown would be a higher premium rate for deposit insurance, applied to institutions which take undue risks. This would be a warning sign, but not a case of bungee-jumping with a frayed rope.
Big is Not Bad
If there is any general theme which runs through Different Drummers, it is that the business and powers of banking institutions are very much a response to the social and political needs of the community. I have tried to explain why the Canadian public found the idea of nationwide branch banking institutions comfortable, whereas the Americans went off in the direction of a unit banking system.
Now we are seeing that the Canadian approach is rapidly gaining ground in the United States. Right now there is major legislation before Congress which will allow American banks to branch across the 50 states, thus taking them back to the situation they had before 1836.
One of the major frustrations for Canadian bankers in the evolution of public policy in the last 10 or 20 years has been the bias in Ottawa and in academic circles against bigness in banking. There are several rules which are slanted against the big banks in the legislation. For example, a big bank has been required to keep a higher level of cash reserves than a small bank, although the risk to the depositor is obviously in the other direction. This bias is still very much a part of public policy, as seen in the government stipulation, "Big cannot buy big."
The thrust of policy is to prevent one big institution from buying another one. We have even gone to the lengths of deliberately encouraging foreign institutions to buy smaller Canadian institutions to make sure that the big banks will not get bigger. In Germany and Switzerland and Britain, this approach would be regarded as ludicrous.
In fact, a large number of small competitors is a recipe for an inefficient financial system. The reason for this is that banking is essentially a system of information storage and retrieval. Small financial institutions simply do not have the threshold size to achieve the economies of scale associated with modem computer systems which are so basic to customer service. This is the swing factor which is forcing American politicians to come to grips with the fact that their banking system is falling behind the rest of the world and can no longer remain the captive of local and regional interests.
But in Canada, there are some who are still caught in a time warp, in which public policy should aim to produce small institutions with a parochial bias. We have been through all that in Canada, many times over. At one time, we had local banks in Nova Scotia, Prince Edward Island, New Brunswick, Newfoundland, Quebec, Manitoba and British Columbia. A century ago, we had almost 40 banks. The reason we have big banks is that a lot of little banks did not work. With any luck, my book will be read in Ottawa, especially the chapter on why we have six big banks!
In the course of doing research for more than a year, I read practically every textbook and history on Canadian banking that has been written. One curious thing I found was that there was very little said about the six per cent legal ceiling on bank lending rates which lasted until 1967. The ceiling was seven per cent from the earliest years of Canadian banking until 1944, when it was reduced to six per cent. I came to the conclusion that the interest ceiling did not matter very much until the post war period, because interest rates were generally a lot lower than six per cent. The yield on government bonds, for example, rarely got above three per cent for much of our financial history.
But the ceiling began to really bite in the 1950s. Even after the banks got the power to make National Housing Act mortgage loans in 1954, there was a long period when they could not do so because they were limited by the six per cent ceiling. The reason the trust companies suddenly expanded rapidly was that they were not limited by the ceiling, and were able to out-compete the banks for deposits with which to fund mortgage loans. This explains the sudden emergence of the trust companies as deposit taking institutions.
When the banks were required to divest their interests in trust companies, a few foresighted individuals moved to get control of the big trust companies, because they realized that the 10 per cent limit applying to banks did not apply to other institutions.
And so we have developed a hybrid system in which the big banks are broadly held, with no one shareholder being allowed to have more than 10 per cent; but the trust companies are closely held because the law allowed it in 1965.
In some ways what happened was an accident of history, as I suppose all politics are. The best analysis of banking ever done in this country was the Royal Commission on Banking and Finance, the so-called Porter Commission, which was published in 1964. The Porter Report provided a very clear and comprehensive strategic plan for the evolution of the financial system. It proposed that the Federal Government should assert its authority over banking, which is supposed to be exclusively a federal matter under The Constitution Act, formerly The British North America Act. It spelled out a practical scheme for defining banking. If that report had been accepted, we might have avoided the tangled web of federal-provincial conflict over financial institutions which is now plaguing the system.
Unfortunately, the Minister of Finance at that time was Walter Gordon, who was preoccupied with his vision of a nationalist and protectionist Canadian economic system rather than the federal-provincial problems. Instead of dealing with the key recommendations of the Porter Report, the government concentrated on blocking any foreign presence in Canadian banking.
In Different Drummers, I explore the famous Mercantile affair, in which Citibank's ambitions for a large Canadian presence were blocked. But the decisive factor which closed the door to a foreign presence in Canadian banking for 15 years was the less well-known plan of the Chase Manhattan Bank to take control of the Toronto-Dominion Bank in 1964.
It was not until 1980 that the Canadian government got around to a policy which allowed foreign banks to enter Canada. In the headlong rush to license foreign banks, there was an underlying assumption that the greater the number of players, the greater the competition. This philosophy of "the more the merrier," displaced prudence and common sense, and helped create the environment for granting a charter to the BCCI. Despite the many disasters of the 1980s, which are continuing in the '90s, it is not clear that the authorities are ready to re-examine their ideological convictions as to what makes for an efficient and competitive banking system. But we're getting there, even at a very slow drumbeat.
The appreciation of the meeting was expressed by Tony van Straubenzee, President, van Straubenzee Consulting, and a Past President, The Empire Club of Canada.