Financial Industry Restructuring: A User's Guide

C.R. Charlton

Honoured guests, ladies and gentlemen: When, as is often done by speakers and writers, a nation like Canada is pictured as a living organism, it is fitting to think of banking as the vascular system of that organism, distributing and purifying the life-blood of a free enterprise economy - money and credit.

As I say, this is a truism, but, in our avid search for originality, it is sometimes forgotten that a truism is also true. The banks of Loch Lomond may be bonnie, as the poet claims. I do not know. I have never dealt with them, but I think we all feel that Canada is very lucky in its "vascular system". To stretch my simile to the breaking point, our economy may sometimes suffer from anaemia, or thrombosis, but on the whole, year in and year out, it functions extremely well.

One of the men that helps keep it that way is with us today. Mr. Allan R. Taylor, President and Chief Operating Officer of Canada's largest bank, the Royal Bank of Canada, with branches in forty countries, exerts a quiet but profound influence in the banking world, both nationally and internationally.

Born in Prince Albert, Saskatchewan, about fifty years ago, Allan Taylor joined the local branch of the Royal when he was sixteen years of age, fresh out of high school. Those were the days when virtually every banker was trained on the job, in the good, hard school of experience. After working in various Saskatchewan branches of the Royal, Allan Taylor was moved east and gained experience in Toronto, Hamilton, New York and Montreal. His first big appointment came in 1971, when he was named manager of the main branch in Toronto. From then on, promotion came rapidly, and after several head office appointments (including head of the International Division), he was elected to his present office, responsible to the chairman.

Mr. Taylor's colleagues describe him as a "team player" known for his ordered, logical, departmentalized thinking habits. They also give him credit for his coolness in helping steer the bank successfully through a period when the world's economic system has been seriously threatened by the possibility of concurrent defaults by major borrower nations.

Mr. Taylor is dedicated to strengthening the rapport and interaction between the theoretical world of the academic and the business world. As a result, he serves on advisory committees of several universities, and is deputy chairman of the Corporate Higher Forum. He is married and has two children, both at Canadian universities. For the next few minutes he will lead us through the complex maze of national and international banking.

With pleasure, I introduce to you the President and Chief Operating Officer of the Royal Bank of Canada, Mr. Allan Taylor.

Allan Taylor

In business and industry, nothing today is more constant or more fashionable than change. When we point with pride to new products and services, we call it "innovation". When change is more far-reaching, we say it is "progress". And if we view it with some reservations, or even alarm, we may call it "revolution" or "industrial restructuring".

Change is well underway in Canada's financial system. More change is coming as the process of regulatory reform begins. Will it be progress? Who will benefit? Government is involved. The industry is involved - and vocal. But the system runs on your money, after all. So I believe real progress depends on you, the customer, having your say in the debate. That is what I want to talk to you about today.

The financial industry in Canada is in the midst of fundamental change. On Bay Street or in Ottawa, you are likely to hear the condition labelled "financial services industry restructuring". That mouthful means that the business of supplying credit, deposit-taking, insurance, brokerage, fiduciary, leasing, factoring and many other financial services to Canadians, will never be the same again. But the term "restructuring" is misleading, if you think what is going on in financial services bears much resemblance to what has been called industrial restructuring.

By and large, among Canada's financial institutions, plant and equipment are not obsolete. Production methods and service delivery systems are not inefficient. Customer demand is not declining.

On the contrary: Take the example of the automated banking machines serving millions of Canadian consumers across the country, as much as seven days a week, twenty-four hours a day. Banks currently have some 2,400 machines in service; credit unions another 500 or so; and the trust companies now entering the field have about 100 machines installed. All told, these 3,000-odd machines are handling an average of about four million customer transactions per week. Different kinds of financial institutions are in the process of linking their networks nationally - and, in the Royal Bank's case, we are linking up with the 3,800 banking machines of the PLUS network in the United States. That is the beginning of giving customers the international convenience and service that they now enjoy at home. Europe and the rest of the world are next!

Naturally, I am not suggesting that all banks are great - or all trust companies, for that matter! But speaking for my own industry, I can say that several Canadian banks are on the leading-edge of change - technological, entrepreneurial, information-based and service-oriented. So then, recognizing that most of Canada's financial sector is already functioning efficiently and well, what do we really mean by "financial industry restructuring"?

The simple answer is that structural change in a healthy, competitive industry means "growing pains". We are changing. So is the world around us. New technology is forcing change. Competition has never been stronger. Customer needs have never been broader. And in our drive to improve customer service, the industry is growing out of its suit of government regulation. You might say, the regulatory suit is already bursting at the seams!

As financial companies outfit themselves for the next decade and beyond, we are seeing rapid growth in the number and variety of financial services offered to Canadian consumers and businesses. In many cases - such as the automated banking machines, or the cash management services now available to individual investors, as well as to corporations - electronic technology is the instrument of change. But the driving force is still the classic "push-pull" of the marketplace - where customers are pulling for new services, we are pushing to get ahead of them and anticipate their needs.

All of us in financial services are struggling for market share-and that is benefiting customers. Those of you in the corporate market will know that pricing has never been more advantageous to you. In the mortgage market, customers have been seeing rates below prime. At the Royal, we have kept increasing our share of the independent business market. That is a hard competitive fight we are winning - and we are proud of it. Because, in every area of the industry, there is no question that the competition is tough, and getting tougher all the time.

... the trend is toward diversification and interdependence in financial services ...

In just the last five years, there are sixty-one new banks in Canada and eight new federal trust companies. And new investors are moving into the field and using the holding company structure to build financial conglomerates. Trilon, Power Financial Corporation and Eaton/Bay Financial are some of the names that may yet become household words in financial services. (Though I think it will be a while before a Liberace tells us he's "laughing all the way to the financial conglomerate"!) Overall, the trend is toward diversification and interdependence in financial services and the companies providing them. And that is changing the basic structure of the financial industry.

From the customer's viewpoint, this simply means that, in Canada today, you can get financial management services from an insurance company; open a deposit account with a stockbroker; go to a bank for discount brokerage services; buy trust services from your department store; or take out life insurance at your bank or credit union, to cover a home mortgage or an independent business loan. And as their services overlap, so do the various segments of the financial industry. A new mosaic is taking shape, integrating old industry structures with the new. And that is progress - progress which could go farther than the current regulatory regime allows, as financial companies compete and customers benefit.

These changes in financial services are important to all Canadians. As consumers or business people, wageearners or pensioners, home-owners or corporate borrowers, savers or investors or both - it is your money that is involved, as I have said. Your assets in deposittaking institutions are our liabilities. You have given them to us expecting service, and because you have confidence in your financial institutions. As users of financial services, you also expect and rely on government regulation and supervision to promote, even to ensure, the soundness and efficiency of the financial system and all its component parts - from banks and investment dealers, to credit unions, insurance firms, mortgage loan companies, and so forth. Any change in industry regulation must maintain your confidence in the system, and in the prudent management and safety of individual financial institutions.

In Canada, there is no question of our looking at anything as dramatic as U.S.-style deregulation of the financial industry. Regulatory reform - "re-regulation", one might say, is more our style. But there is no doubt that the rules are going to change. The only question is "how?" And who should have a more legitimate voice in "how" than the people who give us the money we use?

The fact is, the financial services mosaic has changed in advance of regulatory reform. As I mentioned, the competitive drive into new service areas has made the old suit of rules obsolete - and in many areas, it is straitjacketing the industry. For example, federal trust company legislation was put in place back in 1912. There have been amendments, but no full-scale revision, since. The insurance industry in Canada is still operating under Acts that are fifty-three years old and waiting for a full-scale regulatory review. The Cooperative Credit Associations Act was last revised in 1974.

Not only is much of the legislation and regulation overdue for revision, but it is overdue at a time of change that cuts across all financial sectors. And it is overdue for revision federally and provincially, in eleven separate jurisdictions which do not alway co-operate fully. So, logic would say we need some degree of synchronization in our re-regulation of the financial industry. We must not attempt to do it, bit by bit - this section of the industry now, in one or another of the provinces; that section in a year of two in Ottawa.

Our legislators and regulators, both federally and provincially, are very much aware of the problem. At present, the federal government and five of the provinces - Quebec, Ontario, Saskatchewan, Alberta and British Columbia-are already in the process of examining those parts of our financial system which come under their respective jurisdictions. Here in Ontario, for instance, the Dupre Task Force has recently filed its "Interim Report on Financial Institutions" with a view to amending the province's Loan and Trust Corporations Act, in particular. Almost simultaneously, the Ontario Securities Commission also made recommendations that could change the face of the Canadian investment industry. The task ahead of Canadian regulators is truly monumental!

... The task ahead ofCanadian regulators is truly monumental! ...

The time is long past for going about the regulatory process piecemeal. Yet, as I have indicated, that is all we have to date. As Ontario's Dupre Task Force recently stated, with an outright expression of regret - "no cohesive national process yet exists to accommodate these various approaches". Different levels of government have separate powers over areas of the industry, while the financial industry itself is an increasingly integrated and interdependent system.

As things are, I think we stand a fair chance of mounting this horse and riding madly off in all directions! What else can we reasonably expect, if regulatory authorities try to get the measure of the beast with only a firm grip on a nose or a tail?

You might well ask, then: If the system is healthy, if regulatory change is likely to be piecemeal and disruptive, why not settle for the status quo? If it ain't broke, WHY FIX IT? Again, I think there is a very simple answer.

The status quo has already vanished. The regulatory structure needs rebuilding now, to fit the new pattern of the industry. We have no rules at all for some parts of the industry, such as the holding companies providing financial services through subsidiaries. These and other new inequities in the system need to be corrected - not for the benefit of the players, but for the benefit of the public.

At the Royal Bank, we have come to the conclusion that there is only one kind of change worth making in the regulation of the Canadian financial industry. And that is any change which can be clearly defined to benefit Canadian customers. Sound and beneficial regulatory reform will require careful consideration of such questions as the potential for conflicts-of-interest. Just about every type of financial institution is in the business of deposit-taking today. So, protecting depositors' funds - whether by reform of the Canada Deposit Insurance Corporation, or by other means - is another area that deserves critical scrutiny.

On every issue, the acid-test of any move to deregulate, or re-regulate, is cui bono? "Who profits by it?" "Who benefits?" If it is only a particular industry sector, rather than its customers, then it is not a change for the better, and it is back to the drawing-board!

Unfortunately, so far in the debates on financial industry restructuring, we have tended to hear mainly from partisan voices - people who speak only for one segment of the industry; their own sector's market share; or their private corporate interests.

I would like to ask: Cui bono? Who benefits?

Those partisan speakers will tell you that banks, trust companies, credit unions, insurance and investment firms - government savings offices, treasury branches, venture capital companies - leasing, factoring and mortgage loan companies, not to mention, the financial conglomerates, all add up to only "four pillars" in the financial industry! They will not bother to tell you, for instance, that credit unions (with nearly five times the total assets of the Canadian investment industry) have grown up to be the fourth largest pillar in this colonnade of financial suppliers. And you will not hear them mention the facts, brought out by the Dupre Task Force, that in the allocation of distinct powers to offer financial services, trust companies have eighteen or nineteen such powers; investment dealers have fourteen; the banks have only thirteen; and the credit unions only nine powers.'

Instead, these people will say that the entire industry is dominated by a single so-called "pillar" - the chartered banks. And they will talk about strengthening the weak by weakening the strong, or levelling the playing field, when what they mean is levelling the players! Once again, I ask: Cui bono? Who benefits?

The plain fact is that the market dominance of the Canadian banks is a myth. It is time to explode it! The industry as a whole employs more than 146,000 people in Canada. With more than $90 billion in loans and other assets, the Royal is the number five bank in North America and one of the top twenty banks in the world. But a fair comparison with other sectors of Canada's financial industry would be solely on the basis of domestic assets administered or effectively controlled.

Domestic assets make the comparison fair because, contrary to another popular myth, the Canadian banks do not fund their international loans with Canadian depositors' money. We use foreign deposits to fund foreign loans. So, on the basis of domestic assets under control, you get a realistic picture of the financial industry in Canada, and one that may surprise you. Because,

Zlnterim fort o the Ontario Task Force on Financial Institutions_ (December 1984), pp. 7 and 10 big as the banks are, they make up less than forty-three per cent of Canada's financial industry. And our share of Canadian deposits is declining, and has been declining for a long time.

You may also be surprised to learn that, on this basis, the new financial conglomerates emerge among the very largest financial institutions in this country. For example, in domestic assets, E.L. Financial Corporation, with some $20 billion under its control, is bigger than the National Bank of Canada, and nearly the size of either the Bank of Nova Scotia or the Toronto-Dominion Bank. It seems to me, the playing field is level!

What about the banks' share of individual markets in Canada? Let us look at two areas - consumer lending and mortgage financing - where the banks have made strong competitive inroads since the 1967 Bank Act revision permitted them to move into these fields.

Over the last twenty years, the banks increased their market share from forty to sixty-seven per cent of consumer loans, and from about seven to thirty-three per cent of home mortgages. According to the Royal Commission on Corporate Concentration in 1978, the entry of the banks also increased the volume of consumer credit in Canada. The banks' aggressive competition reduced interest rates on this type of lending and made rates more uniform across the country.

For example, in 1967, when a typical car loan by a sales finance company was costing consumers eleven to eighteen per cent over prime, the banks came in with personal loans at four and one half per cent over prime. And the same fixed-rate loan for your car purchase is available at about three per cent over prime today. Is there someone here who would like to suggest it would have been in the public interest for banks to be barred from these markets?

In residential mortgages, once again, the 1978 Royal Commission commended the banks' competitive drive, reducing interest rate margins. Is that bad for the public? Banks, with their network of over 7,000 branches across Canada, made home mortgages and lower rates available to Canadians in many towns and villages where no other financial institution had been able or willing to lend. Who benefited? The customer. And it shows up in the fact that banks accounted for more than forty-five per cent of the increase in mortgage loans in the first half of 1984 - when no financial service field today is more competitive than mortgages. That market share increase was earned through service.

Those who think "big is bad" and hold the size of Canada's banks against them, let them at least understand what the banks' size represents - not an accident, not just history, not privilege - but a proven record of service to customers. Here in Ontario, the Dupre Task Force recently surveyed public opinion on financial institutions. The poll showed that thirty per cent or less of the population felt "very confident" about the money they might put in trust companies, credit unions or insurance policies. But more than double that number said they were "very confident about the safety of money" in the bank. That is not just size. The public preference is founded on experience.

Yes, there are big loans outstanding with the developing countries; and bank loan losses in Canada have been at historic highs over the last few years. But is that irresponsible management? Or is it unavoidable, when our customers have had to contend with the bloodbath of worldwide recession and record-high interest rates? Does that make everyone who lost money, or even his or her own business, a bad manager? In well over half a century, no one has lost a single cent on deposit with a Canadian chartered bank- a record of prudential management that cannot be matched by any other sector of financial services.

Canadian banks are by no means perfect. But we are very good at what we do - delivering a wide range of financial services, to all of Canada and to much of the rest of the world, safely, efficiently and, yes, at a profit. Our directors are widely representative of Canadian business and industry from coast to coast. They work diligently and effectively to serve the interests of hundreds of thousands of bank shareholders. Our employees are at work around the world, serving Canadian interests and customer interests.

I will match the record of the Canadian chartered banks against any other sector of financial services, any time, any place, and be proud to do it. So, I am personally a little tired of attacks on banks that impugn the integrity of directors and employees, or their competence - attacks that are, in fact, nothing more than thinly disguised attempts to prevent us from building on our record of service. Requests for continued or expanded monopoly powers on certain kinds of financial services, are requests directly opposed to the public interest. And if, on examination of the facts, you the customers agree with me, I hope you will say so - loud and clear!

What does the Royal want from restructuring? Gradually expanded powers for all sectors of financial services. No other solution is fair either to the providers of financial services or, more importantly, to our customers.

How does the Royal believe it should be accomplished? Gradually, and with a regulatory structure that stiffens and strengthens the protections against self-dealing; against conflicts of interest; against imprudent management. But we should also be careful that regulation does not prevent the creative force of the marketplace from continuing to stimulate and guide the industry's growth.

And this time, restructuring must not be piecemeal, with a change federally now for one sector, a change in one province next year for another sector and so on. The external forces - technology, competition, customer demands - and the already large and increasing interdependence of the industry, make that route the wrong one for all of us. But most of all, it is wrong for the people whose funds we hold and whose interests we serve - you.

Are those difficult goals to achieve: gradual, acrossthe-board expansion of powers, harmonized between jurisdictions, simultaneous across sectors, and with better safeguards from regulators? Yes, but not impossible.

For the next several years, at luncheons like this, and in many other fora, you will have the dubious pleasure of being harangued by people like me, and others from the industry. You will observe that our views differ and that our proposals vary. But I suggest that our rhetoric should, in all cases, be subjected to the same test: Cui bono? Who benefits? And I urge you to apply it!

The appreciation of the audience was expressed by Harry Seymour, First Vice President of the Club.