Foreign Banks in Canada

MR. STALDER:

Distinguished members and guests, ladies and gentlemen: Our guest of honour mentioned to me last week that he had just finished writing the fifth version of his speech and that most likely, we would hear version number six today. It is my belief that it is not so much the complex and diverse problems of foreign banks in Canada which led to this amount of rewriting but Dr. Macintosh's responsibility, his caring, his diligence, and his sense for political bearings and basic justice.

In 1980, Dr. Robert M. Macintosh was elected the first full-time President of the Canadian Bankers' Association since its inception by law in 1900, thus marking the fact that banking matters have become more complex, the world smaller, and Toronto a financial centre.

Dr. Macintosh's formal education includes Stanstead College, a B.A. in Economics and Political Science from McGill University in 1947, followed by an M.A. in 1949 and a PH.D. in 1952, post-graduate work from 1949-50 at Trinity College, Cambridge, and finally, a Doctor of Laws degree from York University in 1976.

Dr. Macintosh also served with distinction in the Royal Canadian Artillery, where he was promoted to the rank of Lieutenant.

Dr. Macintosh's career included a stint as Assistant Professor of Economics at Bishop's University in Lennoxville, Quebec, before he joined the Bank of Nova Scotia in 1953. After a most distinguished banking career with the Bank of Nova Scotia, which he terminated in 1980 as Executive VicePresident, he was elected President of the Canadian Bankers' Association.

He holds a number of board and committee memberships and through his directorship in Dominion and Anglo Investment Corp., Ltd., he is acquainted with our Past President, Hal Jackman, and through his Queens Club membership, with our most senior Past President, Sydney Hermant.

Dr. MacIntosh is a man who has a personal opinion on matters concerning him or his office. He is a man of courage, standing up for what he thinks is right or wrong. He is a man of action who gets things done. Ladies and gentlemen, for the second time since 1971-72, please welcome our guest of honour, one of the most prominent bankers in Canada, Dr. Robert MacIntosh.

DR. MACINTOSH:

Mr. Chairman, ladies and gentlemen: It is almost exactly two years since the passage of the revised Bank Act. One of the most important and interesting changes in the amended Act was the provision for the licensing of foreign banks in Canada.

It now seems timely to review the progress which has been made, and the present status of the foreign banks in this country. There is a great deal of public interest in the subject, and it would seem appropriate that, as spokesman for the banking industry as a whole, I might deal with this question today. To be quite honest, your club president might have had something to do with the selection of the subject and the speaker, so he can blame only himself for whatever disasters may befall him and you today.

Before reviewing the present situation, perhaps a little historical perspective would be helpful. Until 1967, there was no legislation whatsoever regarding foreign banks in Canada. This may seem very strange, considering the fact that banking legislation in this country goes back a hundred and fifty years. It may seem even more strange that with one notable exception (Barclays), the large British and American and French banks had never sought to enter Canada up to as recently as 1965.

Why had banking not followed the pattern of multinational investment in Canada so evident in most industries? One can only speculate on this subject, but I would suggest that there are two principal reasons. The first reason is that the banking needs of the country were basically well served by the Canadian banks, which were in some cases quite large in size even from the earliest days, compared to banks in London and New York and Paris.

The second reason is perhaps the more general one that banking had not become extensively internationalized except within the last two decades. Before the days of jet planes and telephones, communication was by post and by sea travel. But banking depends on very fast response times, and very thorough dialogue between customers and borrowers, and between head office and the field. Banking is an industry whose scope is constrained by communications technology, since it is essentially an information-processing industry. There were, of course, some exceptions to this, at least in the money centres of London and New York. And the Canadian banks themselves provided a notable exception, to the extent that they supplied the retail banking services of the British Caribbean as far back as they supplied retail services in Toronto. The banking systems of the colonial powers followed the flag into Africa and Asia, but the generalized, multinational spread of banking is a quite recent phenomenon.

On the other hand, there was not any legal prohibition against foreign ownership of a Canadian bank. In fact, Dutch interests created and developed The Mercantile Bank of Canada, which was chartered first in 1950. What set the cat among the pigeons was the acquisition of the Mercantile Bank from the Dutch by Citibank in 1965, smack in the middle of consideration of the Bank Act revision at that time. The Mercantile acquisition focussed everyone's attention on this issue for the first time, with the emerging nationalistic tendencies of the then government leading to emergency measures to attempt to stop the acquisition.

The outcome of the somewhat ad hoc confrontation at that time was a provision in the Bank Act of 1967 that no single shareholder could vote more than 10 per cent of the voting shares of a Canadian bank, and that the aggregate holdings of non-residents of a Canadian bank could not exceed 25 per cent (except for grandfathering provisions). A compromise deal was made between the Government of Canada and Citibank, whereby the acquisition of Mercantile was allowed to go ahead, but with a provision for gradual reduction in nonresident ownership over ten years. In effect, the 1967 revision of the Bank Act ended up with a total prohibition on foreign banking in Canada, except for the Mercantile.

In the thirteen years following the 1967 revision, up to the revision of 1980, the failure of legislation to keep up with the real world became more and more apparent. Although the Parliament of Canada had effectively eliminated foreign ownership of banks, it had neglected to define what banking is. This has been an ongoing problem for the banking industry for decades, but never more so than at present. By failing to define banking, the federal government has in effect allowed all sorts of institutions to perform banking functions as long as they are not called banks. This includes trust and loan companies, credit unions, caisses populaires, and even the provincially owned Treasury Branches of Alberta. One of the great ironies of the new Canadian Constitution, over which the federal government sought strenuously to assert its central powers, has been the total failure of the federal government to assert itself in the field of banking, over which its exclusive constitutional power was undoubted.

Thus it came about after 1967 that many foreign banks decided to set up provincially incorporated companies in Canada, which were not called banks. By the time the Bank Act was finally revised in 1980, there were about sixty foreign banks represented in Canada, some with several offices. In some cases, these provincially incorporated companies were larger than some of the newer and smaller Canadian, domestically owned banks.

One of the principal objectives of the Government of Canada in the Bank Act revision of 1980 was to sweep these foreign-owned financial companies into the orbit of the federal Bank Act. There were several reasons for wanting to do this. One obvious reason was the fact that Ottawa wanted to establish its authority for the purpose of inspection and control, parallel to its regulatory powers over the domestic banks. Secondly, the foreign bank financial companies in some ways had an advantage over the domestic banks, in that they did not have to keep cash reserves or meet the many other rigorous requirements of the Bank Act. And thirdly, the federal government wished to establish some rationale for negotiating reciprocity with other countries, having in mind the very extensive foreign operations of the Canadian banks.

The federal government's leverage to bring the foreign bank companies under federal control was not considered to be very great, and it rested primarily on denying them the power to employ the guarantee of their parents for their wholesale deposit instruments issued in Canada. In my opinion, the fact that the foreign parents in every case elected to come under the federal regime was to a considerable extent the perception of these world-class banks that it was the proper thing to do, even if it might be contested legally. It also meant that the subsidiary could use the word "bank" in its title, although I am not sure that this would have been in itself a decisive concern to some of the foreign parents, whose names are very well known without the word "bank" being used.

Be that as it may, in the late seventies, some of the foreign bank companies expanded very rapidly in Canada, in anticipation of the revised Bank Act. As it turned out, passage of the Act was delayed three years, for a variety of political reasons. During that period, there was a rapid build-up in their business, since the general intentions of the government in the draft legislation were well known. The key element was the proposal to limit the aggregate size of the whole foreign bank community to 8 per cent of Canadian domestic assets. Within the 8 per cent aggregate limit, the Bill provided for limiting the size of individual foreign bank subsidiaries to twenty times their authorized capital.

Since the Minister of Finance can set the authorized capital of individual foreign bank subsidiaries, he can in effect put a ceiling on the size of each one of them. The scramble to establish size in order to be "grandfathered" within this framework explains in part the 42 per cent compound growth rate in aggregate foreign bank affiliate assets between 1976 and 1980.

Another feature of the revised Bank Act was that banks could be licensed by the Minister of Finance on the recommendation of the Inspector General of Banks, without their having to go through the long and difficult process of an individual parliamentary charter. After final passage of the Act in 1980, the applications flooded in, and the government began issuing licences in July 1981. The licensing process is still going on, but the pool of available authorized capital has been nearly used up. Perhaps a brief explanation of the arithmetic will clarify the parameters of the foreign bank subsidiary licences.

At the present time, the aggregate domestic assets of the Canadian banks, including the foreign bank subsidiaries, amount to about $240 billion. Therefore, if they are to stay within the prescribed 8 per cent aggregate ceiling set by the Bank Act, the foreign subsidiaries can book domestic assets of no more than $19.3 billion.

Since the domestic assets of a foreign bank subsidiary cannot exceed twenty times its capital, then the aggregate ceiling on the total authorized capital of the foreign banks is somewhere around $1 billion, depending on whether all banks fully utilize their capital. Most foreign bank subsidiaries would like to maximize their share of this pool of authorized capital. At the moment, the government has granted "letters patent" to fifty-seven foreign bank subsidiaries, so by dividing this number of banks into the total pool of $994 million allocated so far, one gets an average authorized capital of $17 million. This means that the average bank can reach a maximum domestic asset size of twenty times seventeen, or about $340 million. However, some of the foreign bank subsidiaries are much larger than this, and some much smaller. The top ten represent 58 per cent of total Schedule "B" foreign bank assets and 52 per cent of the total authorized capital. The largest foreign bank has authorized capital of $130 million and assets of $1.8 billion, while some of the smallest foreign banks have authorized capital of only $5 million.

While the aggregate domestic asset limit for foreign bank subsidiaries rests at approximately $19.3 billion, the foreign bank subsidiaries at the moment have about $13.9 billion in domestic assets. In other words, they still have room to add on about $5.4 billion in domestic assets. Another way to state this is that the foreign banks have so far used about 52 per cent of the 8 per cent limit authorized by the Act, and their rate of growth has slowed down considerably. This is partly due to the state of the economy, partly to the fact that some of the foreigp bank subsidiaries are up to their authorized capital limits, and partly to the severe competition in the marketplace. Another reason is that some of the foreign bank subsidiaries grew very rapidly before passage of the Act, for reasons already stated, and have been trying to turn marginally profitable business into more profitable business.

Moreover, the foreign bank subsidiaries now have to face the burden of cash reserve requirements identical to those of the Canadian banks, a cost burden which narrows the spread between borrowing and lending rates by about 2 per cent to per cent. In the two years since the passage of the Act, the foreign bank subsidiaries' aggregate assets have grown at about 31 per cent per annum. In absolute terms, the growth has been from $9.7 billion to $16.7 billion, including about $3 billion of non-domestic assets.

The foreign bank subsidiaries come from seventeen different countries. Not surprisingly, one-third of these are from the United States. There are six banks from the United Kingdom, six from Japan, five from France, three from Switzerland, three from Israel, two each from Germany and Italy, and a dozen others. There are banks from India and the Far East, but none from Africa or South America.

The head offices of the foreign bank subsidiaries are somewhat concentrated in this downtown neighbourhood of Toronto. Currently, there are five in Vancouver, one in Calgary, six in Montreal, and the remaining forty-three in Toronto. This is a great tribute to the climate of Toronto. One bank had intended to establish itself in Winnipeg, but after visiting there last winter, this particular bank decided to abandon its Canadian venture altogether. As we must all regretfully acknowledge, reciprocity does not extend to an equal exchange of climates.

It is sometimes assumed that the foreign bank subsidiaries do not have any branches. In fact, however, they have established seventy-eight branches, as well as the fifty-five head offices. Of these, seventeen are in Vancouver, twenty-five in Alberta, eleven in Montreal, with others in Saskatoon, Winnipeg, Halifax, St. John's, Windsor, Quebec City, and Sherbrooke. More than a dozen of the foreign bank subsidiaries are offering retail services, some with ground-floor walk-in premises.

By and large, however, foreign bank subsidiaries have not been afflicted with the economic and political problems faced by the large Schedule "A" banks on residential mortgages, loans to farmers, loans to small businessmen, and retail banking services to the average depositor and consumer. After nearly three years in the public relations trenches during a period of great economic distress for many Canadians, I would estimate that most of our concerns in the Association apply to seven or eight of the domestic banks and do not, at present, touch the other sixty-odd members of our Association.

This brings us to some observations on the nature of the business being conducted by the foreign bank subsidiaries in Canada. In a community with as many as five dozen members, any generalization is bound to have some exceptions, so that any observations I make about the structure of the foreign banks are not necessarily valid for everyone.

In general, the foreign bank subsidiaries are wholesale commercial banks. They attract deposits in one of two ways: either by raising wholesale deposits directly or through investment dealers; or by borrowing funds, principally in the New York or Euro money markets, and swapping them into Canadian dollars through the exchange market on a hedged basis. These wholesale deposit funds are then either employed in wholesale commercial lending, where the typical size of loan would be between $1 million and $5 million, or invested in short-term securities or interbank deposits.

The definition which we use for a small business loan in Canada is at the cutoff level of a $200,000 line of credit. Some foreign bank subsidiaries operate in this small business loan market, and some do not touch it at all. Studies which have been done would suggest that in aggregate, perhaps half of the assets of the foreign bank subsidiaries would be in loans of $5 million and over and the other half would be primarily between $500,000 and $5 million. This target area of medium-sized commercial loans--sometimes called the "mid-market"--is clearly the field in the Canadian financial system in which the foreign bank subsidiaries have had the greatest impact.

With so many new players entering a field in which the domestic banks were already strong, competition has been

very severe. In part, this took and still takes the form of closely calculated lending rates, although there was not as much room for this as might be supposed, given the increased cost of the foreign bank subsidiaries arising from becoming chartered banks. In part, competition has taken the form of increased personalized services to borrowers in this size range. One symptom of the competitive pressure is the fairly sizable drain of middle management officers with commercial and corporate banking experience from the large banks.

Some of the foreign bank subsidiaries have put a relatively great emphasis on interbank deposits. In a world context, the interbank market is huge, and it is usually thought of in terms of the American dollar or Euro-dollar markets in London, New York, and elsewhere. The interbank markets in Canada would appear to be a Canadian offshoot of the world market, deposits being funded mainly in American dollars, and re-lent from one Schedule "B" bank to another in the Canadian dollar market. At September 30 of this year, the foreign bank subsidiaries together had interbank deposits of $3.4 billion, or a fairly significant 20 per cent of the total foreign bank assets at that time.

The acquisition of loan business is, to an increasing extent, being generated through loan syndications. It would seem redundant to elaborate on the banking problems which have arisen with the concentration of risks, and this alone could account for the increase in loan syndications. Until quite recent years, it was relatively uncommon for a Canadian borrower to divide his account among a number of banks, although the very largest firms sometimes have had two or three bankers. Now, however, there appears to be a growing trend toward loan syndications, and the presence of the Schedule "B" foreign bank subsidiaries is undoubtedly an important factor in this process.

A profile of the foreign bank subsidiaries would not be complete without some observation about their profitability. Since the first tranche of banks was licensed to operate only sixteen months ago, it is obviously too early to make any sweeping generalizations. We have consolidated the income statements of the thirty banks which reported their earnings for the third quarter of 1982.

Their net income after tax for the third quarter was about $6.5 million on assets of $11.2 billion. This works out to an annual rate of return of 0.23 per cent on assets, which is about half the rate of return of the Schedule "A" banks in that same period, a rate which was itself well below the average rate for the last ten years of 0.58 per cent.

The rate of return on equity of the thirty Schedule "B" banks reporting for the third quarter was 3.97 per cent. Obviously, these rates of return are not satisfactory from a longer-term point of view, but undoubtedly, reflect the high cost of starting up a licensed bank. It is perhaps worth noting that our Association office has had to make the leap from quill pen to computer in a short space of time. We used to consolidate some statistics for eleven banks, but this number has now gone suddenly to sixty-eight.

It is our intention at the CBA to provide the financial community and the media with consolidated data for the Schedule "B" banks. In the past, this statistical consolidation function has not been as important, partly because the large banks have the resources to produce their own data, and partly because the highly expert financial analysts in the street are able to produce very comprehensive studies. Since the Schedule "B" banks are not listed on the exchanges, their share values are of no great interest to investors. Nevertheless, the comparative financial performance of the Schedule "B" banks is certainly of interest to all of the banks themselves, as well as to economic observers and the general public. In any event, our output of reports has been one of the few bright spots for the pulp and paper industry in Canada this year.

I believe that the foreign bank subsidiaries have made, and will continue to make, a very positive contribution to the Canadian financial community and to the Canadian economy. In this final section, I would like to comment on some of these positive contributions.

The foreign banks are here to make a profit for their parents, but even if the competitive environment makes it difficult to produce a very good rate of return, most of the parents would probably still feel that a Canadian foothold is a worthwhile part of their worldwide business.

First among the positive factors is the question of people. The foreign bank subsidiaries have created jobs for about three thousand men and women, of whom more than 95 per cent are Canadians. In general, the top officers of the foreign bank subsidiaries are career officers of their parent banks, and are likely to move on to higher positions elsewhere in due course. In a few cases, immigrant officers have elected to stay on as Canadian citizens. This top group has recruited a middle and upper middle management group from the large banks and I would estimate perhaps three hundred to five hundred men and women have moved from the Schedule "A" column to the Schedule "B" column.

There has been acute competition for people in the specialized fields of money market and foreign exchange trading. This has certainly increased the strength and breadth of skills in this field.

An indirect effect on the employment market, which is perhaps not generally recognized, is the significant requirement of the foreign bank subsidiaries for legal, accounting, and computer skills. These resources are an essential part of the infrastructure for a financial community which aspires to achieve an international status. The number of people with some knowledge of the Bank Act has suddenly exploded from a tiny beleaguered group of individuals to a fair spectrum of the legal profession. With a larger general audience, the accounting firms have produced some excellent studies of bank accounting, which is a rather specialized subject. And some of the foreign bank subsidiaries have developed very good computer information systems for internal use and for reporting to head office.

A second obvious benefit is the capital inflow of almost $1 billion, which must be considered a welcome development, especially in a period when we have suffered a very large outflow of equity capital as a result of the National Energy Program and other factors.

One of the intended benefits of the legislation on foreign banks was to obtain reciprocity. In the past two years, the Inspector General of Banks has examined applicants from each country very carefully, in terms of reciprocal access to their markets for Canadian banks. While the Canadian banks were already represented in most other jurisdictions, a direct consequence of the Bank Act change was access to Japan and Switzerland. And it can be assumed that the licensing of foreign banks here has forestalled problems in other countries for Canadian banks.

There is, nevertheless, an ongoing controversy as to the meaning of reciprocity, and as to its extent. Many of the foreign bank subsidiaries, especially those from the United States, regard the 8 per cent ceiling and the limitation on an individual bank's capital as onerous restrictions. On the other hand, most foreign jurisdictions are not free of effective restrictions on Canadian banks.

I have already referred to the competition of the foreign banks in the middle market for commercial loans. In addition, there has been keen competition in the foreign exchange market, and a noticeable increase in the extent of banking calls on customers at their place of business. These are good developments, and I think they are recognized by the Schedule "A" banks as a healthy trend.

No review of the contribution of the foreign bank subsidiaries would be complete without a reference to their significant contribution to the cultural and educational life of this city. Foreign bankers have brought to Toronto a rich mixture of culture and language from Europe and Asia, as well as the very marked contribution to the community from those who share our language, from the United States and Britain. Many of the foreign bankers are multilingual, and I hope this will further embarrass us about our somewhat provincial attitudes in banking, and in the business community generally, to acquiring a second language.

In conclusion, I think it is fair to say that foreign bankers have raised the stature of our profession in the nonbanking aspects of life in our metropolis, and on that happy note, Mr. President, I think it is appropriate to end these remarks.

The appreciation of the audience was expressed by Mr. R. Bredin Stapells, a Past President of The Empire Club of Canada.