Public Policy and the Changing Nature of Canadian Banks

Bonnie M. Brownlee, Communications Director, Style Group: a division of St. Joseph Media and Director, The Empire Club of Canada; Donald Gareth, Grade 12 Student, North Toronto Collegiate Institute; Grant Kerr, Pastoral Staff, St. Paul's United Church, Brampton; Heather C. Devine, Associate in Litigation, Gowling LaFleur Henderson LLP and Director, The Empire Club of Canada; Michael Roach, President and COO, CGI; Kim Anthony, President and CEO, National Bank Financial Group; Malcolm J. MacKillop, Lawyer, Fraser Milner Casgrain LLP and Director, The Empire Club of Canada; Denis St-Onge, Partner and Head of Insolvency and Restructuring Group, Gowling LaFleur Henderson LLP; Louis Vachon, Chairman, National Bank Financial Group and Chairman, NATCAN Investment Management; and Robert Corteau, President and Managing Director, SAP Canada Inc.

Introduction by Bart Mindszenthy

Ladies and gentlemen, many years ago and in a much more serene world, banking in Canada was a reasonably safe haven--a gentlemen's club of honour and mutual accommodation.

But as the years marched on, and as we have become a more competitive country within our broad borders and now beyond and a captive player in a global marketplace, much has changed.

Banking has changed. Bankers have changed. Expectations among consumers and across all sectors have changed.

Today, we see vivid threats and golden opportunities, chilling challenges and the potential for glorious achievements in all aspects of our society, and banking is no exception.

After all, banking and bankers are supposed to be one of the foundation pieces and comfort zones of our national psyche.

So when SAP Canada asked if the Empire Club could develop a series where senior bankers share their thinking with us, we were quick to agree.

Which brings us to today. To the first of the Bankers' Series that will run into late fall, and through which we'll hear about critical issues as perceived by some of the most prominent and influential bank CEOs.

And that brings us to Réal Raymond, President and Chief Executive Officer of National Bank of Canada for the past three years. He joined the organization some 35 years ago. With exceptional performance, he moved steadily up the corporate ladder. The 1990s were growth years not only for the National Bank, but also for our speaker, during which he soared through a number of senior positions.

In addition to his vocation, Mr. Raymond is actively involved with a host of prominent Quebec institutions and worthy causes that are surely too many to recite now. Not to mention his many distinctions and honours.

Today, Mr. Raymond is here to talk about the drastic transformations that have occurred in Canadian banking the past 25 years. And how banking's ambitions, public policy objectives, and politics all come into play and perhaps converge.

Ladies and gentlemen, please welcome to the podium of the Empire Club of Canada the President and Chief Executive Officer of the National Bank of Canada, Real Raymond.

Réal Raymond

Ladies and gentlemen bonjour.

I am delighted to be here today and wish to thank the Empire Club for its kind invitation. It is indeed an honour to address this prestigious tribune.

As you all know, the government's policy statement concerning mergers between large financial institutions scheduled for June 2004 has been put on the back burner following the federal election and the resulting minority government.

Needless to say, the entire financial industry has long been awaiting this statement, and given the current state of affairs I can tell you that resigned pessimism probably best describes the mood of the banking industry.

Although I share the views of my colleagues, I have no intention of burdening you today with a typical bank CEO pitch that lists all the reasons why banks should get additional powers, such as the ability to merge with other banks.

Instead, I would like to outline my views concerning the key forces that are shaping the legislative and regulatory framework. In doing so, I will try to present a balanced and objective view of the different issues from my particular standpoint as CEO of Quebec's largest bank.

Mergers between big banks are indeed of a lesser concern in Quebec than in Ontario as regional banks and credit unions are the main players in the Quebec financial market. While Quebec and Ontario are at two extreme positions, it should also be acknowledged that there is across this country a complete spectrum of in-between situations as far as competition among financial institutions is concerned.

That being said, three important currents characterize the national legislative and regulatory framework:

o First, the objectives of banks, which are constantly seeking new revenues and efficiencies to deal with the new forms of competition that come onto the market every day.

o Second, Ottawa's public policy goals on issues including competition, industrial organization, consumer protection and the availability and cost of financial services.

o And third, the political dimensions; in other words, the beliefs and convictions of our MPs that are partly shaped by the influence of various pressure groups.

It goes without saying that in the context of a minority government the political dimensions overshadow other considerations.

These dimensions include the unlikelihood that allowing bank mergers would receive unanimous support in the House of Commons as well as the desire of government to avoid clashes with interest groups whose points of view range from a call to prudence to outright hostility.

While clearly a central factor, the political dimension should not be overemphasized. Beyond it, there are also legitimate public policy objectives that guide elected officials and civil servants when they set up the laws and regulations governing the industry.

These include:

o Making sure the financial system remains solid,

o Protecting consumers and depositors,

o Ensuring a healthy level of competition with wide availability of financial services at competitive prices, and

o Fostering adequate financing for businesses, both big and small.

The importance attached to these objectives comes from the central role of the financial system in the Canadian economy.

It also reflects the near-daily consumption of financial services by Canadians and the impact these services have on their lives. Whether we like it or not, financial products are a subject that is of interest to everyone.

We also need to recognize that the pursuit of these economic policy objectives was a powerful lever that helped banks grow during the post-war period.

Until 1954, banks were not allowed to lend to individuals. The changes made to banking laws at that time gave the banks the right to provide insured mortgages and secured personal loans.

In 1967, the 6-per-cent ceiling on interest rates was lifted and banks were given wider latitude to offer mortgages and personal loans. This meant that they were able to jump into the consumer market with both feet.

This sea change, coupled with a strong demographic and economic boom, led to a broad expansion of bank branch networks as banks were able to satisfy previously unmet consumer demands.

The legislative and regulatory opening of the banking industry continued during the ensuing decades.

In 1987, banks were given the green light to purchase brokerage firms, which was a great step for banks in being able to penetrate the wealth management market. Since then, this niche has accounted for an increasingly larger share of our revenues.

Then, in 1992, banks were permitted to acquire insurance companies and trusts and their staff to provide investment advice to customers at the branch level.

I am talking about banks, but the fact is that everyone in the financial industry was given a wealth of new powers in the context of the general liberalization and rapid growth of financial markets both domestically and internationally.

In Canada, market liberalization met several crying needs that characterized markets of earlier years:

o An inadequate supply of mortgage offerings, which forced government to lend directly to consumers;

o The difficulty and cost of getting personal credit;

o The need to capitalize the brokerage industry, which seemed under threat by the big foreign firms;

o The urge to rescue several trust companies;

o The need to make financial asset management services accessible to the general public, not only to the wealthy.

In all these cases, the banks did such an effective job of meeting consumer needs that today they are the main players in almost all of these markets.

Not only did banks gain market share, but their customers got value for their money in the process. Many independent studies have concluded that the cost and availability of financial services in Canada, for both individuals and small and medium-sized businesses, compare very favourably with that of other countries.

A good example is the comprehensive study by McKinsey for the Task Force on the Future of the Canadian Financial Services Sector, which concluded that "Overall, Canadian financial institutions stack up well by most quantitative measures in the delivery of financial services to individual Canadians."

To summarize, in the post-war period there was a strong alignment between the evolution of the financial sector and our country's public policy objectives.

During that time it was fairly easy to convince politicians that it was in everyone's interest to open up financial markets.

At the same time, numerous measures were introduced to reinforce and assist the emergence of other financial institutions:

o Canadian markets were opened up to foreign banks, which can now operate in Canada in a variety of forms, and

o The framework was put in place for the demutualization of the big insurance companies.

These measures were introduced in large part because of a desire among federal authorities to facilitate the rise of credible competition to the banking industry, particularly from medium-sized regional institutions.

These institutions are far from negligible in Canada. Institutions other than the Big 5 banks take in about 30 per cent of deposits and loans originating from individuals and small and mid-sized business.

These financial institutions account for around 30 per cent of the retail market in Western Canada, and, in Quebec; they gobble up--fasten your seat belts--about two-thirds of individual and SME deposits and loans.

Ontario is a different story, as these institutions have a market share of under 10 per cent. Although large institutions have a strong presence in communities throughout the province, Ontario has no large regional banks.

Sure, credit unions are active in many communities and within large unionized businesses, but they lag far behind in terms of reach and market share when compared to Quebec or Western Canada.

The visibility of the big banks and the much smaller presence of other deposit institutions, especially in large urban centres, have shaped Ontarians' perception about Canada's financial system.

Ontario, and Toronto in particular, play definitive roles in shaping Canadian public opinion regarding financial institutions.

This is partly due to the region's electoral weight and its representation in Parliament and in cabinet, but also to the large concentration of jobs as a result of the number of financial services firms headquartered in the Queen City. In addition, many of the country's most important media, interest groups and decision makers make their home in Toronto.

Since the Big 5 banks play such a dominant role in Ontario, it is sometimes hard for Ontarians to understand that this isn't always the case in the rest of Canada.

The presence of many monoliners in mortgage loans, credit cards and mutual funds attenuates the Ontario reality. But, for a large share of the population, these fast-growing new suppliers are far from being a full substitute for the day-to-day proximity banking services delivered by branches and ABMs.

However, the situation I face as CEO of the largest bank in Quebec--or the sixth of the Big 5 banks--is completely different. In Quebec, the biggest of the Big 5 banks ranks only fourth among financial institutions when measured according to number of branches.

In "la Belle Province," mergers between Big 5 banks could even have a direct, and positive, impact on competition since they would create stronger banks relative to National Bank and Desjardins.

So, what are the implications of the current landscape for banks?

The question of mergers continues to be highly charged politically and remains of great interest to opinion makers and a large part of the population.

As I have already mentioned, banks have been successful when asking Ottawa for new powers to help them better serve Canadians.

However, much of the general public views the freedom to merge as a response to corporate objectives. While these objectives, which include striving for greater market cap to facilitate foreign acquisitions and better compete with large international institutions in global capital markets, may be laudable, they are certainly not very high on the wish list of most Canadians.

The industry must therefore be prepared to face, at best, consumer indifference. At worst, they could be met with hostility.

As Canada already boasts one of the safest and most inexpensive and efficient banking systems in the world, convincing Canadians that they would get a better deal as a result of mergers is indeed a tough sell.

I am getting the same reaction from large corporate clients, who are merging left and right for the same reasons that are motivating the banks.

Many of them think that mergers are good for their industry, their customers and for Canada in general. But strangely enough, they are not so sure when it comes to bank mergers.

Everybody wants more competition and benefits that affect them personally. The bottom line is that the general public would not easily support the idea of big bank mergers.

What about public policy considerations?

In my opinion, public policy considerations can be divided into two groups: those dealing with competition issues and those related to the structure of the Canadian financial system.

In general, the competition aspects of bank mergers could be adequately dealt with by the due process led by the Competition Bureau.

The bureau has much wider latitude with respect to oversight of bank mergers than it does for other mergers. And, just as important, its decisions regarding bank mergers cannot be appealed to the Competition Tribunal.

If the ultimate public policy objectives were to ensure that bank mergers did not prevent strong national competition and that post-merger banks maintained a wide variety of offerings in local markets, then a Competition Bureau review would suffice.

At least, that is our opinion at National Bank. We are on record as saying that the examination process should be tightened and corrective measures refined and that divestitures resulting from the mergers should consist of veritable regional franchises.

If the government wanted to, it could calm the public's concerns about bank mergers by setting in motion and strongly supporting the due process of the Competition Bureau.

However, we're not even there yet.

There are other public policy considerations that need to be addressed even before the first merger proposal is considered.

Ottawa has stated that, and I am quoting the June 2003 Department of Finance paper:

o Canada's five largest bank concentration ratio is one of the highest in the world, with approximately 77 per cent of total deposits held by the top-five banks in 1999.

o The concentration ratio for the life insurance sector is also one of the highest in the world, with the top-five life insurance companies accounting for about 73 per cent of consolidated assets in 1999.

The opinion that the Canadian financial system is already too concentrated is debatable when one considers our geography, our economy and the situation in similar industrial countries. But it remains that the industry has to deal with Ottawa's views.

We must also remember that the federal government's efforts to generate greater competition have not yet yielded all the effects they hoped it would.

We know what happened to many trust companies. With the notable exception of HSBC and monoliners such as ING and MBNA, the inroads by foreign banks in the retail market have been limited, and some players have exited the market.

Insurance companies and mutual fund firms have not yet taken advantage of the new freedom extended to them to directly partake in the Canadian payment system.

As we can see, opening the door to greater competition does not guarantee that new players will enter the market.

Indeed, the lack of large-scale entry is likely a reflection of the fact that the banking sector is already highly competitive and is serving Canadians well.

The irreversible nature of bank mergers is giving policy-makers even more food for thought. Neither politicians nor senior civil servants like to commit themselves to controversial decisions that cannot be reversed in the foreseeable future.

In the final analysis, the decision of whether to allow bank mergers will be highly political, but one that will nevertheless be driven by important public policy considerations.

To the extent that public opinion today is by and large against mergers and that politicians have been able to invoke public policy considerations to question them, we can certainly appreciate all the uncertainty surrounding the final outcome.

However, we should by no means exclude mergers between the big banks, but it could be an awkward process.

For example, it could result in a beauty contest where several projects are submitted for approval and only one or two are chosen. Similarly, strict conditions could be imposed, making mergers impracticable or hard to justify financially.

At the same time, we can expect that concessions will be demanded not just from the merging institutions, but also from the industry as a whole.

In any case, you can bet that MPs and ministers will intervene in the process, creating much uncertainty as to the outcome.

Nevertheless, prohibiting mergers will not stop the industry from evolving.

Did you know that since 1998 consolidation of the deposit-taking network has led to the closing of 1,300 branches, almost one quarter of which were due to the TD-Canada Trust deal?

Put differently, the moratorium on bank mergers did not prevent the disappearance of local points-of-service equivalent to the entire network of one Big 5 bank.

However, in most cases this was because branches that were located close to each other in urban areas were grouped together.

But branch numbers just tell part of the story. In line with technological progress and changes in consumer preferences, banks have been investing heavily in remote banking channels that are at least as convenient for the customer.

In fact, banks are not investing less in proximity banking; they are investing differently.

A couple of words on the bank-insurance model before I conclude. The consensus within the industry is that we should allow mergers between large banks and insurance companies.

If we look again at this issue from a political and public policy point of view, the bank's chances of gaining this freedom seem much better.

On the one hand, Canadians recognize the opportunity to streamline their financial transactions. Public opposition to bank-insurance consolidation comes more from a reflex backlash from the insurance industry than it does from the general public.

On the other hand, it is relatively easy to show the productivity gains in service distribution and from increased competition that would result from these mergers.

So, in a nutshell:

o Politics are important, but they are not the only dimensions in play.

o Rhetoric aside, public policy considerations were the driving force in molding the Canadian financial system during the post-war period for the benefit of consumers. Let's hope that will continue.

Finally, given Ontario's central position in the political debate and in defining public policy, the strong and atypical dominance of the Big 5 banks in this market has a major impact when concentration and merger issues are raised.

In conclusion, I would like to present National Bank's position on mergers.

National Bank strongly supports the industry view that mergers could be beneficial for financial services consumers, the banking industry and the country in general.

I am also convinced that problematic competitive situations can be adequately addressed by the Competition Bureau using a new framework. This concept could be effective even in Ontario where massive divestments are likely to take place, as it would enable a new player to enter the market with a ready-made customer base.

Mergers would lead to the reshaping of the financial industry. The post-merger landscape would be dotted with new mid-sized regional or national players that are very committed to the retail market and with larger institutions that are better equipped to become the global financial powerhouses that Canada sorely needs.

That seems like sound public policy to me.

Thank you for your attention.

The appreciation of the meeting was expressed by Malcolm J. MacKillop, Lawyer, Fraser Milner Casgrain LLP and Director, The Empire Club of Canada.