Banking in Canada—The Next Ten Years

MR. KARN:

Reverend Sir, distinguished guests, ladies and gentlemen: For our first meeting in the New Year, your speakers' committee felt that an address on Canada's financial position--an appraisal of our economic strengths and weaknesses--would be quite timely.

Although I was hoping that our guest of honour might reveal pearls of wisdom regarding what 1977 held in store for us, I was mindful of ancient Chinese proverb which states, "Forecasting very difficult, particularly forecasting future." Notwithstanding this difficulty, our speaker is going to look ten years down the road so far as banking in Canada is concerned, under the latest decennial revision of our Bank Act.

One of the notable pillars of world banking as we know it today derives from the imagination and foresight of Sir Gilbert Heathcote who purchased from his fellow British citizens their bundles of notched wooden sticks at 30% of the original value of the loans to the Crown which they represented, and which the Crown had chosen not to repay. He consolidated them and obtained from King William III, in 1694, a royal charter to found the Bank of England with stated assets totalling 100% of the original loans. The Scots could not stand idly by and incorporated their own Bank of Scotland in 1695.

Almost two hundred years later in 1893, the Canadian Bankers' Association was formed, and incorporated by special act in 1900, one of its recorded purposes being "to arrange for lectures, discussions, competitive papers, and examinations on commercial law and banking."

Because of our close relationship with the United States and Britain, Canada has shown a great deal of ingenuity in selecting from the legislation of both countries. While the British system is the prototype of branch banking, the U.S.A. has a unit banking system.

This has given rise to ten chartered banks in Canada today, handling more than $114 billion of the country's assets. Largest among them is the Royal Bank of Canada, formed in 1869, now with assets of $26.6 billion and operating 1,540 branches. The Royal is one of the five Canadian banks out of a total of 43 created since Confederation, which have not failed, wound up or merged. Its success may be due in part to the fact that it was founded in Montreal. Although Bay Street is now flexing its banking muscle, one of which appears to be gold plated, Montreal at one period was described as the city of banks and churches. Its people were said to have spent much of their time laying up their riches in this world and the next.

Our guest of honour today is a second generation member of the Royal Bank of Canada family, having joined that bank in St. Stephen, N.B., in 1939 where his father was manager.

After four years of overseas service during World War II he took a Bachelor of Commerce degree from Oalhousie University and returned to the bank, this time in Fredericton.

He later moved to the Montreal area and by 1964 had been appointed Assistant General Manager at head office. The next eight years saw him progress through the offices of District General Manager in Winnipeg--General Manager, Canadian Districts in Montreal-Vice-President in Toronto--VicePresident and Chief General Manager in Montreal. Four months later, on February 28, 1973, he was appointed a Director and named Executive Vice-President and Chief General Manager.

In addition to the above, he is serving as President of the Canadian Bankers' Association.

It is a pleasure to give you Mr. Rowland C. Frazee to speak on the subject "Banking in Canada--The Next Ten Years".

MR. FRAZEE:

Mr. Chairman, ladies and gentlemen: It is with a great sense of honour that I appear before you as your first speaker of the New Year. I would add that this sense of honour is heightened by thoughts that must be in all our minds in this first week of 1977. For reasons that are amply clear the next twelve months may turn out to be one of the most crucial periods in our history. Fortunately for me my own assignment is limited to the decennial revision of the Bank Act, an important subject but not one that goes to the deepest roots of our society.

In addressing this subject I want to try to see it in the perspective of the next decade. Events now move so rapidly that the future is always upon us sooner than we expect, and it is important at least to try to see its main outlines. However, despite the attention the revision has received in the media I am sure that many of you will not be quite certain about what the issues are and where we stand today, and I will therefore take a few moments to give you some necessary background.

According to the terms of the British North America Act, banking is a matter of federal jurisdiction. Pursuant to this constitutional authority, the federal parliament, over a century ago, passed the Bank Act which since then has set out the duties and powers of the main commercial banks known in Canada as "chartered banks".

By custom established right from the outset, this statute has been completely revised every decade, subject to some delay in the event of war or political factors. The present Act expires on July 1, 1977, unless Parliament provides otherwise.

In anticipation of this event the former Minister of Finance, Hon. John Turner, announced that he would receive briefs from interested parties by the fall of 1975, and his successor, Hon. Donald Macdonald, carried forward this program. Briefs were submitted by most financial interests in September and October 1975. Following consideration of these briefs the Minister issued a White Paper on Banking in August of last year with a request for comments to be submitted by October 15th. Comments by several organizations were submitted and most have been made public. Almost concurrently the Economic Council of Canada issued a study covering much the same territory. This has provided further material for examination but has not required a public response.

The next step will be submission of a bill to Parliament to revise the Act, probably within the next two or three months. This will be followed by extensive hearings before separate parliamentary committees of the House and Senate and then debate in Parliament with final enactment, we hope, by next summer.

So much for the process. If it seems protracted and painstaking you are- -quite right--it is. There are very substantial demands on the banks, both directly and through our Association, over a period of at least two years, and for some of our people even longer. In the meantime we are having to cope with other legislation, some of it very complex, and, incidentally, keep the banking system running. Nonetheless we regard this as our top priority since our whole basis of operation for the next decade is at stake.

Let me turn now to the issues that have emerged, and here we begin to see more clearly the future implications of the revision.

One of the main problems we addressed in our brief is the narrowness of existing banking legislation. As I mentioned earlier, the Bank Act applies only to the chartered banks. In our view a great many other institutions are now in the banking business, and these do not come under the Bank Act. We have in mind trust companies, credit unions, caisses populaires and some other organizations that provide services very much like banks. These now account for nearly one-third of banking business in Canada as measured by their share of either assets or liabilities.

Most of these entities are provincially incorporated and come under provincial supervision, but this is not the same as being subject to the Bank Act. A chartered bank, for example, comes under the direct monetary influence of the central bank, and must keep non-interest bearing reserves with the Bank of Canada.

Obviously, in saying that others are in the banking business as well as ourselves we have a fairly clear idea of what we mean by this statement. Certainly it involves a good deal more than the making of loans. All kinds of businesses make loans--finance companies, insurance companies, mortgage companies, even department stores that have installment payment plans. Nor does it involve simply holding the public's money. All sorts of organizations are also doing this--insurance companies, mutual funds, etc., which are not in the banking business.

Banking as we see it relates to a distinct function that is of unique and vital importance, namely the creation and the control of the money supply of the economy. Contrary to popular impression, the real money supply of the country, for all practical purposes, is the millions of dollars of deposits that are transferred daily by the simple process of writing a cheque. It follows that the organizations which hold such chequable and transferable deposits are carrying on one of the key functions of banking. The additional function of lending money rounds out this concept but is secondary to this fundamental test of cheques and transfers within the payments system.

Many units in the businesses I have named -trust companies, credit unions, caisses populaires and mortgage loan companies--are in this payment system because they allow their customers to use their deposits as money by writing cheques on them. We suggest, therefore, that they are carrying on the banking function and should be treated as banks for this particular side of their business.

But why do we feel that this is important?

One reason relates solely to the kinds of obligations and responsibilities that are required and expected of an organization carrying on the banking function not only in Canada but in most countries of the world. The principal obligation is to be a part of the mechanism that has been established by the state to control the money supply and to share in the broad social and economic responsibilities that arise from this position. The essential element in meeting this requirement is the maintenance of a regular and direct relationship with the central bank, the Bank of Canada, the practical vehicle for maintaining this relationship being the deposit with the Bank of Canada of a reserve similar to that now required of the chartered banks.

Not only is such a deposit--or alternatives which I will mention in a moment--essential for establishing the cash base of the banking system by which the Bank of Canada regulates the money supply, but it is also required for the settlement between financial institutions of outstanding balances between them arising from the daily clearings. Under the White Paper proposals, a balance for this purpose will be a regular part of the operation of the proposed Canadian Payments Association.

As a matter of historical development, probably arising from the fact that most of the so-called near-banks are provincially incorporated, the control mechanism of the central monetary authorities has not been extended to them. I do not wish to imply that they have not been subject to control and supervision by provincial authorities. On the contrary, for some purposes they have been subject to fairly strict control. I am only saying that for monetary purposes they have been outside the direct influence of the central bank. This would probably have continued to be a tolerable situation if the near-banks had not grown to be such a substantial element in the deposit holding and money-creating side of the financial system, now representing about one-third of total Canadian assets and liabilities.

The Governor of the Bank of Canada has made an often-quoted statement to the effect that up until now he does not feel that the influence of central bank policy has been restricted by lack of direct control over the near-banks. I believe he has agreed, however, that to control the money supply through the diminishing base of the chartered banks would be inequitable.

We believe it is entirely possible that the near-banks will continue to grow in the next decade at the pace of the last ten years, which, as I have indicated, has exceeded that of the banks. If they do, the leverage through which the Bank of Canada must exert its monetary influence will be further weakened. At some point in time it will be weakened to such an extent that central monetary policy either will become ineffective or else the pressure that will have to be exerted on the banks in order to influence the whole financial system will be quite inequitable. We do not know when this will happen but we see a danger of it happening in the future and the time to take action therefore is now, when results can be achieved with minimum cost to all concerned. You do not wait till your house is on fire before you buy insurance.

As events are developing this will be one of the most crucial--perhaps the most crucial--issue of the revision. Both the government's White Paper and the Economic Council's study in effect made the same proposal that I have explained--namely, that the near-banks maintain a reserve at the Bank of Canada. In both cases the rationale has been substantially the same as I have given, with varying degrees of emphasis on different aspects. With this degree of agreement on the proposal one might well ask why I have felt it necessary to devote so much time to it.

My main reason for doing so is that in briefs and statements issued since the White Paper appeared all the non-bank financial institutions and the provincial governments have spoken against it. Unfortunately, in many instances it has seemed to me that the reasons for opposition are based on false premises or misunderstandings. The non-banks, for example, allege that the banks are afraid of their competition and wish to impede their ability to grow. Nothing could be farther from the truth. Competition among financial institutions in Canada has produced one of the best financial systems in the world; all we argue for is that competition be on an equitable basis. Both non-banks and provincial governments argue that this is a clandestine attempt by the federal government to take over control of their provincially incorporated and supervised institutions. However, it has never been an accepted principle of law that regulation of a company's activities be limited to the jurisdiction under which it is incorporated. Provincial governments, for example, regulate the activities of federally incorporated trust and loan companies; and conversely, provincial institutions are never exempt from appropriate federal regulation. Besides, it has not been suggested that the day-today supervision of provincial financial institutions be transferred to the federal government or in any way reduced. In fact, it is even proposed that if provincial institutions do not wish to keep a deposit with the Bank of Canada directly they would be permitted to deal with another institution that does, provided this is reflected in the deposit which that institution holds at the Central Bank.

In the light of this brief discussion, it is essential to recognize one fundamental principle. In the case of institutions, including banks, for which the provision of payments facilities to customers is an integral part of their business, the only relevant issue is whether the proposal imposes undue burdens or represents a fair and reasonable obligation in the public interest. For those institutions for whom provision of payments facilities is less important, it becomes a matter of choice for them to offer these services or not, in the knowledge that membership in the system carries with it certain national obligations. Bearing this in mind, we can appreciate the peripheral nature of many opposing claims; and arguments and counter-arguments can be weighed accordingly.

Undoubtedly the other issue in the revision that requires attention, and that quite urgently, is the whole problem of foreign banks operating in Canada. We have been fairly free from direct intervention by foreign banks over the years, and the recent entry in some form or other of possibly one hundred or more such banks has created new problems, largely because we were unprepared for it. The Bank Act now provides against the full ownership of a Canadian bank by non-Canadians, but is completely silent on whether foreign banks can simply open an office in Canada or buy into existing non-bank entities or even set up new provincial companies to carry on lending and money market operations. As a result of this vacuum, combined with the growing attraction of Canada as a market for financial services such as leasing, foreign banks have appeared in great numbers and are now operating as competitors, free of any of the restraints that apply to the Canadian banks.

As an industry we have urged for at least the last two years that the federal government take action to regularize this situation. In the White Paper, proposals are made for this purpose. These have met with very mixed reception from foreign banks, and indeed have given rise to differences of opinion among the Canadian banks.

The essential feature of these proposals is that foreign banks will be offered the opportunity to establish fully-owned Canadian subsidiaries under the Bank Act. Such subsidiaries will have the full powers of a Canadian chartered bank, but growth will be restricted in various ways, particularly as to their capital, number of branches, and share of the total commercial lending market in Canada. The nature of their treatment will also depend on the way Canadian banks are treated in their own countries.

This whole issue is complicated by the fact that the foreign banks are already here, and that among themselves they have quite different interests and objectives for the Canadian market. Moreover, the Canadian banks, largely because of differences in size, and in the extent of their foreign business, react in different ways to the presence of foreign banks in Canada. I do not mean by this that there is disagreement about permitting the presence of foreign banks, but rather that there are wide divergences of view regarding the conditions that should govern their future operations and growth. The communications received by Ottawa relating to the foreign banking proposals have considerably outnumbered those received on any other part of the White Paper. It is obviously a very lively controversy, and a subject that poses a delicate dilemma for the federal authorities.

The foreign banks are here to stay--there can be no doubt about that. However, as with the non-banks, many of these institutions are provincially incorporated, and because they are foreign owned and in many instances are not carrying on a full banking business in Canada the issue of jurisdiction between governments is a contentious one. Furthermore the question of foreign ownership was thought to have been settled with the arrangements for the Mercantile Bank and it is natural that new proposals to permit foreign ownership should be influenced by existing policies. In order to accommodate this situation the government has developed restrictions on growth that no doubt are unpleasant to many foreign bankers and may in fact work against Canadian banks in countries that require reciprocal treatment equal to their own.

As to the rest of the revision, there remain a couple of problem areas. One of these is the extent to which we will be limited in developing services to our customers through computers. The White Paper proposes very severe restrictions on our ability to serve clients in this way, and we feel that this is unfair and potentially inefficient. For many business customers, the banker is in a far better position than an outside person, because of his intimate knowledge of their affairs, to provide those special financial services that are most suitable. As I have said, the banks may be unnaturally and severely restricted in this area, and we hope that further consideration of the interests of our customers will result in a more liberal interpretation of acceptable banking services.

The other problem area is in the proposed restrictions on our ability to hold shares in other corporations. Granted, there are dangers in allowing bank ownership of industry to go as far as it has, for example, in Japan and Germany. However, we still feel that the net is being drawn around us too tightly in the White Paper proposals. The general condition is that we will be restricted to ownership of 10% of shares, except for some subsidiary corporations that are for special purposes, such as housing. This contrasts with the present law, which under certain conditions allows us to own as much as 50% of the shares of a corporation. We feel that the present law is fair and has not been abused, and have urged reconsideration of this proposal. In particular the right to hold for a reasonable time as many as half the shares of a small corporation can be instrumental in establishing the company, and enabling access to the public market for capital.

There are a great many other subjects covered in the White Paper. For example, there is the collection of proposals that will make it easier to establish a bank or to convert an existing financial institution into a bank in order to increase the number of units in the industry. Also important are some minor additional powers that will be given the banks, such as leasing and factoring, which are notable mostly because the Canadian banks are almost the last in the world to be allowed to enter these fields. In some other areas, such as the handling of RRSPs, RHOSPs and similar plans, the banks will be able to act without the services of a trust company if they wish. In the security trading area one right has been removed and the balance of existing rights confirmed. These are welcome changes for the bankers, but I can assure you that we regard them with considerably less excitement than do our competitors who have tended to exaggerate their importance.

To conclude this rather abbreviated survey of a most important subject, I would like to leave you with the thought that the key to much of the future development of the financial system in Canada will lie in two trends.

One of these will be the trend toward an ever-broadening scope of activities for individual elements in the industry, with a consequent blurring of the sharp lines that have existed in the past. This is now apparent enough in Canada, where it is already difficult to distinguish the retail outlets and the services offered by non-banks from those of the chartered banks. The inevitability of this trend is suggested in the conclusions of a survey of banking systems of other countries of the world recently issued by the Economic Council of Canada.

The other trend will be an increasing standardization in the rules that apply to the same financial function. I do not imply by this that control and supervision of financial functions will become highly centralized--only that there will be an increasing tendency for supervisory authorities to adhere to the same standards in controlling all financial institutions. The most dramatic instance of this is the attempt of the EEC countries to "harmonize" their banking and other laws, but there are several examples of it already in Canada, particularly in the relative uniformity of provincial legislation governing some aspects of financial markets and institutions.

Given these very strong pressures in the industrialized world the proposed revisions of the Bank Act take on new and dynamic meaning. The further broadening of banking services, modest as it is, gives recognition to the strong drive toward universality of financial functions, at least among deposit receiving institutions. Other measures, such as the easing of transition to bank status for existing institutions and the lowering of reserve requirements for new banks, offer attractive incentives for becoming a chartered bank. This becomes particularly appealing for some of the provincially incorporated non-bank institutions which might consider that existing provincial restrictions are too binding. From this may develop further federal innovations, such as a federally incorporated savings bank, which we have heard is under consideration. What provincial response will be made to this type of development is difficult to forecast, but it is clear that in some areas the provinces are now expanding the limits of particular organizations under their jurisdiction. Under the current revisions of the Ontario Credit Unions Act, for example, there will be very little distinction between a credit union and a bank operating in Ontario.

Along with the process of regularising the status of ten, twenty-five or fifty foreign banks with substantial increase in their powers, there is ample evidence of increasing competition in the years ahead. This seems to be an inevitable consequence not only of the Bank Act revision but of strong pressures that arise from universal trends. I believe in competition as being in the public interest, as do my colleagues in the other banks, and look forward to the years ahead as offering great challenge to us all.

The appreciation of the audience was expressed by Mr. Robert L. Armstrong, a Past President of The Empire Club of Canada