The Extension of Bank Control in the Financial Services Industry

Head Table Guests

Alex Squires, Security Analyst, Brenark Securities and a Director, The Empire Club of Canada; Robert Douglas, Vice-President, Financial Advisor, Midland Walwyn Capital and a former Director, The Empire Club of Canada; Leon Atkins, OAC student, Malvern Collegiate Institute; The Rev. Edward Jackman, Historian, Archdiocese of Toronto; John Crow, former Governor, The Bank of Canada and President, J & R Crow Inc.; John Curtin Jr., Partner, Goldman Sachs Canada; The Hon. Edwin Goodman, Partner, Goodman, Phillips & Vineberg; Gareth Seltzer, Vice-President, Private Banking, Guardian Capital Advisors and a Director, The Empire Club of Canada; Tom Long, Managing Partner, Egon Zehnder International Inc.; Kiki Delaney, President, C.A. Delaney Capital Management; Dominic D'Alessandro, President and CEO, Manulife; and Warren Goldring, Chairman and CEO, AGF Management Limited.

Introduction by David Edmison

"The Order is
Rapidly fadin
And the first one now
Will later be last
For the times they are a-changin."

Bob Dylan wrote these words 33 years ago. His hit song, "The times they are a-changin," became the anthem for an entire generation. This was the sixties, a decade of experimentation, protesting the established order and a time which marked rapid change in the social fabric of society. Some areas were insulated from this maelstrom of change; the four pillars of the financial community, banking, trust, insurance and brokerage remained solid and distinct. They had clearly defined roles and regulations in place, allowing each to serve their niche markets.

Today, the theme of Dylan's song could just as easily refer to the torrent of change witnessed in the financial community, now ruled and run by the children of the sixties. The most dramatic changes are being felt right now. The four financial pillars are no longer as distinct and functionally separate. The regulatory environment has also evolved. The relaxation of the "Glass-Steagall Act" in the U.S., the revisions to the " Bank Act" and "Financial Services Act" in the U.K., and changes made and considered in our "Bank Act" have heightened the level of competition in the industry.

The banks have been allowed to enter areas in which they were previously forbidden to compete. Corporate loans, the mainstay of the banking industry, while still important, are playing a smaller role. In order to increase market share, banks have crossed both national and traditional industry borders. Now, Canadian banks are able to fulfil investment banking functions through their discount brokerage subsidiaries and are permitted to sell a variety of products including insurance and mutual funds directly to their customers. These industry-wide changes have fostered much debate about the proper role for the banks; what is fair and what isn't.

With us today to present his views on the industry from his unique perspective as head of Canada's largest financial services organisation serving the individual investor, is Mr. Robert Schultz, Chairman and CEO of Midland Walwyn Capital. Midland Walwyn serves more than 435,000 clients through 1,500 representatives, working out of 135 locations across Canada.

Mr. Schultz was the key architect in the merger of Midland Capital Corporation and Walwyn Stodgell Cochran Murray in 1990 and the subsequent merger of Midland Walwyn with Dean Witter Reynolds (Canada), in 1991. Prior to this he spent over 16 years with three of Canada's major investment houses in senior management capacities. Our guest is a Chartered Accountant and holds a B.A. from the University of Manitoba. He is past Chairman of the Board of Directors of The Investment Dealers Association of Canada. He is also a member of the Canadian Special Olympics, the Council for Canadian Unity and serves as Chairman of the PC Ontario Fund.

In the current review of federal government legislation Mr. Schultz will share with us his insights and offer advice on what action Ottawa should take to help sustain efficient Canadian markets. The outcome of this debate is important because as we all know "the times they are a-changin."

Ladies and gentlemen, will you please welcome our special guest, Mr. Robert Schultz.

Robert Schultz

Thank you very much, David, for that kind introduction. It is a great pleasure to speak today to The Empire Club. With a crowd of this calibre, and given the time of year, it's awfully tempting to make a pitch for some of the RRSP dollars in this room. In fact, minding my business and competing to meet customer needs is something I'd much rather be doing than talking about public policy issues--especially at this time of year.

But sometimes, when you step back from the ebb and flow of day-today business, you see something going on that concerns you. You have to speak out. The issues I want to speak out about are:

• the concentration of banks' power in our financial system and;

• means of levelling the playing field between bank and non-bank players.

This is timely, because RRSP sales are not the only thing going on as I speak today. In Ottawa, the Department of Finance is preparing a white paper on the regulation of financial services in Canada. This white paper is a critical milestone in the review of financial services that the government undertakes every five years. The past two reviews, ending in 1987 and 1992, brought sweeping changes. They dealt with basic issues, essentially demolishing in two steps the sector's traditional "four pillars" structure.

After all this sweeping change, many expected the 1997 review to be a fairly quiet, technical exercise. But I don't think that's how it's turning out. People are speaking out. Non-financial companies are making their voices heard. The media are weighing in. Parliamentarians are listening.

Why? Because the assumptions on which these changes were made have proved to be questionable. Their implementation did not provide adequate safeguards against the dangers that many foresaw and the basic issues are extremely important to our economic future.

In the 1990s, five years is a long time in business. A lot has happened. It has become clear that a lot more is going to happen, before Canadians get a chance to examine these issues again in 2002. The time for a full and honest examination of our financial system is now. The government must take this opportunity to address concerns about concentration of power and to level the playing field in financial services.

Let me briefly recap how the four pillars have come down, and what's coming next. In 1987 the federal government announced that Canadian banks would be able to purchase 100 per cent of investment dealing firms effective in 1988. In 1992, it allowed banks, trust companies and insurance companies to undertake most of each others' business functions, directly or through subsidiaries. What's happened since then?

Well, the investment firms were the first to go. Within eight years of the federal green light, bank-owned investment dealing subsidiaries have absorbed 70 per cent of the industry's assets. The remaining 30 per cent is divided roughly evenly between Canadian independents, such as Midland Walwyn, and foreign-owned dealers.

The trust companies were next. In part because of long-standing business difficulties in that industry, the number of trust companies in Canada declined from 82 in 1984 to 57 in 1994. And furthermore, banks have gone from controlling zero per cent of trust company business in 1992, to 45 per cent in 1994. Although trust companies are now permitted to establish banks, not one has done so.

And the next pillar in line is insurance. Although insurance companies have been permitted to establish or acquire securities dealers, almost no one has done so. And while they were permitted to set up trust companies, they have only established a few. Meanwhile, four of the five major banks have at least one life insurance company. And only one of the six major life insurance companies has established a small, Schedule 11 bank.

As you all know, the banks' drive to further penetrate the insurance industry is far from over and this would lead to an even greater concentration of bank power. The highest profile issue of the 1997 review is whether or not bank-owned insurance companies will be permitted to sell their products directly through bank branches. For those who favour a competitive financial services sector, such a move would be a giant step backwards.

What has happened, it is plain to see, is a swift and massive extension of bank control of the financial services sector. In 1990, banks already held 57 per cent of the assets of the financial services industry. That amount has only increased since then. The recent history of financial services in Canada looks less like pillars coming down, and more like dominoes being knocked over.

Now, I want to ask a question that hasn't been asked nearly enough over the last 10 years. Is this extension of bank control a good thing? In offering an answer, I want to draw primarily on my field of expertise, which is the investment industry and the Canadian capital markets. Canada's capital markets are one of the country's great success stories. They are one of the foundations of our economic achievements as a nation. The efficiency, accessibility and reputation of our markets have made them among the world's best. They have proved to be a superb instrument for the building and expansion of our country.

Canada's markets are highly competitive. In proportion to the size of our economy and our population, our markets raise twice as much capital as the United States. On a proportional basis, we also trade more stocks and bonds. Large companies and small ones get access to private and public capital at a comparatively low cost. Our capital markets have been a good place for corporate Canada to raise money and a good place for corporate and individual investors to make money--which is the way it should be. Let me say that I see nothing inherently wrong with banks being in the investment industry. Midland Walwyn and the other independent dealers are ready, able and eager to compete with bank-owned firms. But the banks do not seem content with a 70 per cent share of the investment business. I believe that the trend towards further bank domination of the capital markets is a threat to those markets.

What's the threat? Let me tell you. Total bank domination of the investment industry will give the banks control over the capital markets themselves. And that control would be all too easy to abuse. With complete control of the Canadian capital markets, banks could fix the price of going to the markets. They could steer corporations to seek commercial lending instead. The major bank-owned dealers would also have oligopolistic pricing privileges. This would allow them, if they wished, to simply hike the cost of issuance and up their profit margins.

Look at the experience of countries like Germany, where the banks have a dominant position in the markets. OECD statistics show us that the cost of raising capital in those markets is indeed higher and in that country, the banking industry is much less concentrated that in Canada. In 1990, the top five German banks held only 25 per cent of banking assets. In contrast, in Canada in 1993, the top five held 62 per cent. In France, the top five banks control 51 per cent of banking assets; in Italy, it's 43 per cent; in the UK, 31 per cent; and in Japan, 23 per cent. In the U.S., it's 12 per cent. So let's be clear about this: when it comes to concentration, Canada is not the norm. It is the anomaly.

So what does this mean for Canadians? The capital markets tend to under-perform in any country where bank ownership dominates the investment industry. This means an increase in the cost of raising capital, which will make us less competitive as a nation. In Canada, our problem is compounded because so few banks dominate. As President Woodrow Wilson said: "A concentration of the control of credit... may at any time become infinitely dangerous to free enterprise." The Americans have been running their financial system to prevent that for 75 years; how long will it take us to figure it out?

There is a risk in going to only four major dealers. There is a risk in having highly concentrated banking, with operations across the field of financial services. Taken together, the risk to the capital markets of having only four major players, all of them owned by the major banks, is very great indeed.

So what should be done to contain that risk? Well, the first and most important step is for independent firms to keep competing and competing hard. I think I can speak for my friends in the other independents in saying that we are doing that, and we will keep at it. The second step is to put a stop to the anti-competitive abuses, perpetrated by banks, that unfairly advantage their investment dealer subsidiaries. Some of you may have seen the media stories and editorials about the banks' anti-competitive abuses relating to the investment business. Concerns about tied selling, discriminatory lending policies and other issues have been receiving increasing attention.

I believe that, if left unchecked, these practices will result in the absorption of the remaining domestic independents, which would give the major banks a dangerous amount of control over the markets and a dangerous amount of control over consumers as well. I get dozens of calls and letters from individual consumers complaining about bank tied selling. Many of our client customers tell me that when they go for a loan, their banker tells them that they should bring their RRSP to the bank. They tell me that when they write a cheque to their securities account, the clearing bank calls them and says: "Hey, why aren't you using our investment dealer?"

This is clear abuse. In the United States, banks' tied selling of lending and securities and discriminatory capitalisation of dealer subsidiaries is prohibited by law. This is in a country where banks' market power is spread out across thousands of institutions. If anti-competitive bank practices vis-a-vis securities are a concern in the land of 10,000 banks, it's absurd that they aren't in a country where only five major players dominate the field. I urge the government of Canada to adopt the U.S. Restrictions on tied selling and discriminatory capitalisation financing as soon as possible.

The first step is independents working to compete. The second step is prohibiting banks' anti-competitive practices.

The third step towards maintaining strong capital markets is levelling the playing field, so that independents can compete fairly with bank-owned conglomerates.

Look at the payments system and Interac. Now, as many of you know, the banks' control of access to Interac has been a subject of public debate for a long time. Right now, it is impossible for Midland Walwyn to offer its customers, at reasonable commercial rates, an ATM card with which they can access their securities accounts. I know, because we've tried. The government of Canada has been concerned too, which is why the federal competition bureau has been investigating the Interac situation for years. Last fall, they arrived at a proposed settlement with Interac, after concluding that Interac players have "abused their dominant market position." Those are their words, not mine.

Midland Walwyn and Richardson Greenshields, are now arguing before the competition tribunal that the proposed settlement doesn't really solve the problem. Others, from sectors as diverse as mutual funds, payroll services and retailing are arguing about the same thing. I'm not going to rehearse our arguments in front of you, but suffice it to say that we are facing some tough sledding in prying Interac open. It's ironic, because according to the most recent OECD statistics, Canada has one of the lowest rates of electronic financial services utilisation in the developed world. I find it extraordinary that a quasijudicial effort is needed to allow more players to offer electronic financial services to their customers.

Perhaps even more extraordinary--and here is where I really turn into a heretic--is the prohibition on establishing investment accounts for consumers from which they can directly write cheques. Now, when you ask people if this should be allowed, the answer often comes back: "No, that can't be permitted, because cheque writing is a core banking function."

Well, let me ask the question: "Why?" No one even tries to define banking any more. The federal Bank Act can get no more specific than to say that banking is the business carried on by banks. If no one can say what banking is, how can anyone legitimately define what a "core banking function" is? And this leads straight to a core question at the heart of the entire recent evolution of our financial sector. Banks can do the same things everyone else does. Why can't everyone else do the same things banks can? Why do the dominoes have to fall only one way, which is the way banks want them to?

I think these are the sorts of questions all of us--especially the federal government--have to ask ourselves as the review unfolds because the basic question here is: "Who calls the shots in the Canadian economy?" For over 100 years, more or less, governments did. But that is changing now. There has been a revolution in the way economics function, not only in Canada but around the world.

This revolution has been driven by technology, globalisation and above all, by consumer choice. It has made our governments realise that they must allow market forces to take the lead in providing prosperity to Canadians. And I support that. But a philosopher once said that "no sooner has the tide of revolution receded, than is it replaced by... a new bureaucracy." It would be terribly ironic--not to mention economically dangerous--to watch remote, accountable and bureaucratic governments retreat from our economic life, only to have them replaced by remote, unaccountable and bureaucratic bank conglomerates. The market revolution we are undergoing in Canada is just that--a market revolution. I believe that economic power should be placed in the hands of market participants--users, investors, consumers, you name it.

Banks should be a part of it, too. And if they play their part well, they are entitled to all the profit they earn. That is the basis of competition, which, I think you will all agree, is the only basis on which an economy can ultimately more forward.

I am not asking for special protection. I am not seeking to turn back the clock. The four pillars are gone. Independent firms do compete and will compete in the new financial services universe. We should be able to do so without anti-competitive hindrances. We should be able to do so on a level playing field, where we can offer more customers greater access to our products.

That's the best way forward: for Canada's capital markets; for capital market participants; and for Canada's economy.

Thank you.

The appreciation of the meeting was expressed by Alex Squires, Security Analyst, Brenark Securities and a Director, The Empire Club of Canada.