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5

The Banking Empire – Deregulation of Canada’s Financial Industry Pt 3

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As Part 2 examines, the “Big 5″ Canadian Banks: Royal Bank of Canada, TD-Bank, Scotia Bank, CIBC, and Bank of Montreal have increasingly benefited and profited from deregulation and market liberalisation.

This piece examines the effects deregulation has had on the big 5 Canadian banks.

The internationalization of financial markets since the late 70’s, coincided with the deregulation of Canada’s financial industry which began in the early 80’s.

Since deregulation policies were introduced, Canadian banks significantly expanded their domestic and international operations.

Yet even as they grew larger, their relative size and importance in comparison to competitors in other markets made them look weak and ineffective.

Their international ranking based on assets had declined relative to other international banks.

In 1970, three Canadian banks were amoung the 25 largest banks in the world ranked by assets.

By the 1990s, Canada’s largest bank (RBC) was ranked approx 50th in the world. The chart below depicts the trend.

Even with the presence of deregulation, Canadian banks were still losing ground in the international markets.

Realizing the implications of impending foreign competition, the major big 5 banks called for greater market liberalisation with open arms.

Diversification

Financial deregulation by the federal government allowed the banks to diversify and expand their financial activities.

The Canadian financial services sector was no longer divided into distinct pillars characterized by specific financial institutions and their core business activities, namely banks, insurance companies, brokerage firms, and trusts.

In this liberalized environment, the banks diversified and took over many domestic firms. Entire sections of Canada’s financial industry, in particular the independent brokerage firms and trusts were merged with, or bought out.

The marketplace became dominated by a small number of large, diversified financial conglomerates functioning on a transnational scale.

Successive Canadian governments, whether Liberal or Conservative, encouraged and facilitated this growth and consolidation. Occurring roughly in the same time frame, public policy at all levels also closely followed the recommendations of the major banks and the rest of the corporate elite.

In the decades past, Canadian regulators favoured safety and soundness over competition in the financial sector. Domestic firms were protected from foreign competition and oligarchies of large national firms were encouraged.

In order to expand abroad and make foreign acquisitions, Canadian banks argued they must consolidate and gain size in their home market.

Being focused on foreign expansion, the Canadian banks “banked” on a trend toward international liberalisation, and in order to gain access to foreign markets through bilateral and multilateral trade negotiations, the Canadian state was required to facilitate increased foreign access to the Canadian market.

Of course, Canada’s big banks were quite happy to concede foreign access of the domestic market in which their dominant position is well entrenched (thanks to existing regulations), in order to gain access to larger foreign markets.

The Canadian banks have then proceeded in arguing that the foreign ‘threat’ requires further domestic consolidation. Thus they have used a double-ended strategy in order to secure their interests.

The amendments introduced to the Bank Act in 1987 and 1992, granted chartered banks and insurance companies permission to own trust companies. And the banks went to acquire trust companies very aggressively. Part 2 looks at these specific regulatory changes in greater detail.

The examples of RBC, TD Bank, and Scotia Bank prove that the financial institutions were seeking further consolidation to amass more profits for their shareholders and for their executive bonuses.

RBC bank spent almost no time at all, having quickly acquired Dominion Securities, Voyageur Insurance Company, and finally Royal Trust in the years between 1988 to 1993.

Scotia Bank purchased National Trust some 5 years later, in 1997, and TD Bank completed a merger with Canada Trust in 2000.

The Canadian banks also have numerous agencies running operations in the United States, Latin America, the Caribbean,  Europe,  Asia and all over other parts of the world.  Almost half of the earnings made by these banks are generated outside of Canada. Scotiabank alone, has operations in some 50 countries and continues to be a leading bank in the Carribean and in Central America, with operations in 25 countries within the region.

Out of everything that was happening in the past few decades, one thing was clear. The liberalization and expansion of financial markets around the world increased the power of financial interests relative to governments, non-financial corporations and communities.

Thus, financial claims demonstrated real authority on their owners. Stockholders demanded receiving higher profits, and this kept corporations downsizing and outsourcing operations even during the best of times. Bond holders also pressured state and local governments to trim their budgets, and bankers and bondholders, along with global state institutions such as the IMF, forced severe economic restructuring on debtor countries.

This is clearly apparent today with the prime examples of Greece and Ireland.

While the deregulation of financial services has been a common theme since the 1980s’, the Canadian state retains a prominent role in shaping and supporting the financial services sector.

And though the state has liberalized market activities, still, some significant restrictions remain on foreign businesses in the form of corporate organization and patterns of ownership.

Regulatory structures have been consolidated and their mandates and roles have been formalized to respond to a more competitive marketplace.

As a result, the state continued to play a vital role in providing consumer protection, ensuring prudential stability, and acting as a lender of last resort.

Paul Martin’s rejection of two large bank mergers in 1998 was an example of the continuing relevance of the state.

However, the insatiable appetite for more profits, and greater growth, led to even more fiscal consolidation.

This monolithic vision by the big banks eventually led them to announce proposals for bank mergers, that, had they succeeded, would have profoundly changed the outcome of the Canadian economy as it stands today.

 

 The Proposal for Mergers

1998 – Four Canadian banks had proposed a merger.

These were to be mergers between TD Bank and CIBC, and between Bank of Montreal and RBC. At that time, the Council of Canadians launched a well publicized cross-country campaign to convince the federal Finance Minister Paul Martin to reject the proposed mergers and bring greater accountability to the banking industry.

At that time, the Competition Bureau also became alarmed and sent out a series of letters to the respective banks on the course of action to take. The Competition Bureau is an independent agency with a mandate to protect and promote competitive markets and enable informed consumer choice.

While the Bureau lacked the regulatory authority to allow or disapprove of mergers, its role had been to review the proposed merger for its impact on competition and make the results of its review known to the Banks.

The Bureau sent a copy of the letters to the Minister of Finance who had the ultimate authority to approve the merger under the Bank Act.

And on December 14, 1998 Paul Martin had ruled against the mergers of the big banks.

However this didn’t just end here.

The debate over bank mergers re-emerged just a few short years later.

In 2002 the Federal govt committed another public review, through the House of Commons Standing Committee on Finance and the Senate Committee the year after.

These reports began looking into some of the policies that governed bank mergers.

A report based analysis of the two reviews were conducted by the Public Interest Advocacy Center (PIAC) with funding from Industry Canada.

The report was titled: Bank Mergers and the Public Interest.

The report concluded (just as many before it), that there was no persuasive evidence that consumer choice and access to banking services would be enhanced by large bank mergers and no evidence that the cost of banking services wold be reduced under a bank merger. The report argued that in the public review that was done, there was little representation from the public or consumers, to the legislative committees that were tasked with this public review. Rather, there was significant representation and input by banks.

Indeed, this turned out to be true. Evidence of this can be found in the Standing Senate Committee on Banking, Trade, and Commerce report, as found in Appendix 4.

The Committee heard from or received submissions from 23 banks and only 2 public interest groups.

The situation of consultations wasn’t much different in the House of Commons Standing Committee on Finance.

Found in Appendix C & D of the report titled: Large Bank Mergers in Canada. The House of Commons Committee heard from or received submissions from 12 banks and 4 public interest groups.

Some of the testimony heard included words from several high ranking individuals at the financial institutions.

Before the Standing Senate Committee on Banking Trade and Commerce on November 25th, 2002, CEO of the Bank of Nova Scotia Peter Godsoe said,

You merge for only one reason, in my view. There is one overwhelming reason that can be given to the Canadian people, which is the overall scale of our equity base. Why do you need the size? It is to grow and expand outside of Canada faster.

And before the Standing Committee on Finance on Feb 4, 2003, former Chief Economist with TD-Bank Douglas Peters said,

Bank mergers are about raising prices and reducing service to the public and concentrating economic power in the hands of the few.

A member from the Competition Bureau was also present at the House of Commons Committee in which they summarized their findings.

So what did we find in 1998? We found that the barriers to entry or expansion were high. There is a need for a large branch network. They represent large sunk investments. Customer inertia is high. Market share does not change very much except by acquisition. The banks built up significant brand names through decades of advertising, which was reinforced by large numbers of branches throughout the country. Technology is an important factor here, but we found that in some ways it was more of a complement than a substitute, and in some ways it can actually make changing banks a little more difficult…In terms of the effect of competition, at that time, given the four merging banks, what you had left was the Bank of Nova Scotia and some regional niche players, which were important to some parts of the country but not all. Foreign competition for the products we were most concerned about, personal banking and SME (Small and Medium sized Enterprises) products, was minimal.Obviously there was also the removal of two vigorous and effective competitors

 

The banks were not successful in a bid for mergers in 1998 when the fed government blocked this decision.

Having diversified their business activities quite extensively already, there was little room left for the big banks to grow in Canada.

They were tired of competing for market share and the big banks hoped to grow through teaming up with each other through mergers.

Even more important to the big Canadian banks were the opportunities offered by foreign markets, especially in the US.

Unlike Canada, the US had many mid-sized and small state and local banks.

As consolidation proceeded in the US, the Canadian banks wished to expand their presence in the US market by acquiring some of the smaller US firms.

However, while the banks were looking at expansions south of the border, there still remained the question for competition at home.

Increasing Financial Competition

 

The Standing Committees at both the House of Commons (HoC) and the Senate also heard that more needed to be implemented in order to increase competition in Canada.

Both Committee put forward recommendations that urged the Government to do more on this.

The HoC Finance Committee recommended that the Government review the legislative and policy framework to ensure that barriers to entry and expansion were eliminated.

The committee suggested in its report that greater foreign competition might occur if regulatory barriers to entry for branches of foreign banks were lowered.

It recommended that the Government take immediate steps to remove any impediments to the emergence and growth of credit unions in Canada.

The Senate Banking Committee recommended that the Government undertake a review of barriers to entry into the financial services sector – including tax changes – that would foster competition.

It also noted that divestitures of assets could be used to foster the growth of existing and new competitors in the financial services sector in Canada, in the context of a particular transaction.

In the late 90’s and early 2000’s, the Government introduced a number of measures to increase competition in Canada.

In 1999 the Government allowed foreign banks to operate directly in Canada through a branch of the parent bank.

Furthermore, foreign banks wishing to operate in Canada were permitted to have the same range of investments as Canadian banks. They were allowed to establish more than one branch and could own more than one bank. And like the domestic banks, they benefited from the streamlining introduced into the approvals system.

Since 2001 the financial sector framework (through Bill C-8) encouraged new firms to enter the financial services market, making it easier to start a bank, trust and loan company or insurance company, by lowering the minimum capital required to begin operations and allowing a small institution to be held by a single shareholder.

Bill C-8 strengthened the credit union system, helping the credit unions to implement their plan to make themselves stronger and more competitive nationally.

The Government also opened access to the payments system to life insurers, securities dealers and money market mutual funds, so that they could offer Canadians a broader range of options for managing their money.

With respect to the Senate Banking Committee’s concerns about taxation, the 2003 Budget announced that the federal capital tax that applied to all industries (including the financial services sector), would be eliminated in stages over a period of five years.

This would serve to illustrate why the corporate tax rates were reduced in the subsequent years following this announcement.

The reduction of the corporate tax rate can be seen in the Canadian Labour Congress study found here.

The economic crisis in 2008 served a wake up call for those in the financial community.

Out of the crisis, throughout the western world, it was the Canadian banks that performed best.

The shocks in the system were absorbed well.

This even led to former Chief of the US Federal Reserve Paul Volcker to comment back in 2009, that the system he was arguing for “looks more like the Canadian system than the American system.”

Part 4  addresses the assumptions made by the world financial community, as well as whether Canadian banks were actually as “prudent” as claimed, and whether they are actually “safe”.

Content:

Part 1 – Into the Boiler Room

Part 2 – Historical Context

Part 4 – Banks Prudently Regulated to the Teeth

Part 5 – Testimonies from Both Sides of the Divide

Part 6 – The Life Insurance Industry and Bank Woes

Part 7 – Outward Expansion

Part 8 – Risky Mortgages

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