The Future Of Banking (Canadian)

The Future Of The Canadian Financial Institutions

As we approach the information age, society and all of its components must change. Some elements of society are doing this quickly, embracing new technologies and production methods. In this way they are preparing themselves for the future. Other segments of society realise that change is inevitable but for their own benefit try to slow it down. Thus while they delay change they do not in fact stop it. Finally, there are those elements of society who fear change. This is however; a dying breed, if not today then assuredly tomorrow.

The Financial Institutions of Canada neither fear change nor are attempting to slow it down. Instead they are embracing change and new utilising new technology at a rate perhaps unparalleled in society. In this way, they are preparing themselves to compete in a global village. Technology alone can't do this for them. In order to compete globally, the Financial Institutions require the revision of the existing regulations designed with a past time period in mind. Due to these regulations they are currently restricted from acquiring rivals or merging to better meet market conditions. This has proven incredibly harmful in the past twenty years as the relative size of our financial institutions has fallen off of the global charts. This has been harmful not only to the industry but to the country as a whole.

If the Canadian Financial Institutions are to have a future globally then they must be allowed to expand both at home and abroad. To date, artificial barriers imposed through the governments have resulted in a financial services sector less efficient than if it were simply left to competition in a free market system.

Technology will be a major determinant to the successes or failures of the Financial Institutions in the years to come.

This is true not only because Canada is not an island and is subject to major forces of internationalisation,

pressures affecting the industry (such as technology, internationalisation and changes in the economic environment, including demographics and changed inflationary expectations). trade-off between prudential regulation and freedom of competition.

limits on what government can do, particularly in light of the pressures imposed by internationalisation and technology. Canada is not an island. Parliament cannot legislate vibrancy.

In our free market system, principal reliance should be placed on competition and disclosure as the disciplines to ensure that businesses operate efficiently and effectively. That is particularly important because more interventionist rules are difficult to formulate in a balanced way, particularly in times of change. Yet some rules going beyond competition and disclosure are generally accepted to be necessary in the financial services sector. Prudential regulation, designed to require prudent conduct on the part of regulated financial institutions and to minimise the occurrence and cost of failures, is applied in Canada as in other free market countries. Other rules, dealing for example with consumer protection and privacy issues, are generally accepted. What seems important to us is that all such rules should be carefully formulated so that the degree of intervention in the business operations of financial institutions is the minimum necessary to satisfy the particular public policy objective, and reflects an appropriate balance between prudential regulation and other objectives.

This Part canvasses issues concerning the conduct of financial institutions in the marketplace. The underlying philosophy is that competition and disclosure should be the principal motivators of financial institutions to operate in the public interest. However, regulatory controls are appropriate for prudential purposes and in furtherance of other overriding policy objectives. Any such intervention should be rigorously tested,

Questions include whether the sector is now so international that we can accept international competition as a sufficient discipline in the Canadian domestic market. Also, are there market segments where the benefits of competition are less available because customers are uninformed? Similarly, we must test the adequacy of disclosure, both at the level of the institution itself and at the level of the products that it sells. Disclosure has costs, and the trade-off must be assessed between the benefits that disclosure provides and the extent of those costs.

Since our terms of reference identify a number of specific objectives that should be served by the financial services sector, analysis is appropriate as to whether the sector is as responsive as it should be to these various objectives. Specific questions in this connection are what policies might be adopted that would further encourage financial institutions to retain jobs in Canada; whether the institutions perform adequately in the creation of employment through the financing of other businesses; and whether there are segments of international financial markets where Canadian institutions (perhaps on a co-ordinated basis with government) could attract a significant market share.

The distribution of financial products is being increasingly affected by technological developments. Responding principally to consumer protection concerns, a variety of rules surrounds the distribution process.

More generally, is the sector adapting to technology to the extent that it should?

The discussion paper notes the vast expansion in the size of pooled funds (mutual funds, pension funds and segregated funds of life insurance policies) and inquires whether there are aspects of their operations on which recommendations would be appropriate. Specifically, has their growth created risk for the Canadian system, and are they contributing to the extent that might reasonably be expected to the development of entrepreneurial and knowledge-based businesses in Canada?

The regulatory regime designed to mitigate potential impact of conflicts of interest is canvassed. The Task Force will consider whether the existing rules (including the Bill C-82 changes) are adequate to deal with the potential for transactions or decisions of financial institutions being, or perceived to be, affected by non-arm's length relationships, by the fact that the institution has various profit centres with disparate interests or by other conflicts or appearances of conflict.

Throughout our work in this area, the Task Force will be cognisant that unregulated financial institutions compete with the regulated financial institutions across substantial segments of their business. On a functional analysis basis, it may be difficult to support the application of regulations dealing with various issues to regulated institutions, while not applying corresponding regulations to unregulated institutions. Of course, it must be recognised that it is the entity to which regulations are applied, rather than the function; prudential considerations may dictate the difference. Comments on the treatment of unregulated financial institutions would be welcome.

The "upstream" ownership rules affect Schedule I banks and would affect a large demutualized life insurance company. They dictate that no one investor may hold more than 10 per cent of any class of shares of the particular institution. This means that a take-over bid for such an institution is not possible. It means that such an institution cannot be owned by a holding company that might also control corporations engaged in unregulated or less-regulated activities.

The application of the upstream ownership rules to Schedule I banks has important implications for competition and also for Canadian management of the banks: while the rules do not restrict the extent to which non-Canadians may own these institutions, they do preclude the acquisition of effective control since associated investors may not own in excess of 10 per cent. One of the principal motivators for these rules is concern with commercial links and outside control of major financial institutions. Among the issues to be considered is whether the rules regarding domestically-owned Schedule II banks constitute an undue barrier to entry into the banking industry. Should the historic Canadian attitude that bank charters ought to be granted only sparingly be modified as one way to enhance the equality of regulatory treatment, and to provide the opportunity for increased competition?

There are "downstream" ownership rules that affect not only banks and life insurance companies, but also other federally-regulated financial institutions. These form part of the prudential requirements and are influenced by the desire to avoid major downstream commercial links and the impact of conflicts of interest in the allocation of credit. The Task Force will be reviewing these downstream ownership rules and seeks comments, particularly as to whether the degree of intervention that they represent is the minimum necessary to attain the relevant public policy objectives.

the federal financial institution statutes require Ministerial approval as a condition to a wide range of transactions, including mergers between regulated financial institutions. This authority is used, for example, to enforce the "big shall not buy big" doctrine that currently limits mergers between major Canadian financial institutions. The Task Force will canvass these provisions and their application, attempting to formulate recommendations as to how Ministerial discretion should be exercised. We will also consider what types of transactions should be caught by the rules concerning mergers.

the internationalization of trade and investment flows are reinforcing the globalization of wholesale financial services and are, in turn, being themselves reinforced by this globalization.

-Changes in the macro-economic environment, in particular low inflation - together with the demographic effects of the baby boom - are leading to changed needs and preferences for retail financial services. New forms of intermediation allow the benefits of equity investment to be more closely tailored to individual risk preference.

most important driver of change is technology, and the tremendous increase in power and reduction of cost that has occurred in communications and information processing. I am struck by the observation I have heard that if the rate of productivity increase and cost decrease that we have seen in the computer industry over the past 25 years had applied to the automobile industry, I would be able to buy a Rolls Royce for less than a dollar and drive around the world on a tank of gas

Financial services have become, first and foremost, an information industry. And so it is no wonder that they are being fundamentally transformed.

rapid, and accelerating, pace of change.

Credit Card Expertise to Canada" -"Great West Life Tops Royal Bid for London Life"

These Canadian developments reflect trends that are certainly evident internationally. They also indicate the cascading effect of change both on Canada's domestic institutions and on Canadian consumers.

big financial institutions merge. Others announce new acquisitions or enter into new markets. Still others refine their product lines to become the best in the world in a narrower sphere of activity.

There are concerns that the Canadian regulatory regime may be increasingly out of sync with the reality of changing imperatives for business. It is suggested that the system should allow greater competition and more flexibility in organisational structure and business powers.

-It is claimed by some, for example, that there is not enough competition in some Canadian financial services markets - particularly price competition and access to credit and particularly in regional and non-urban markets. We are told that more providers would be welcome and would benefit consumers. Conversely we are cautioned that policies which would reduce the number of providers would be harmful.

-At the same time, we are being told that the existing restraints do not allow Canadian institutions to pursue the strategies and alliances that are increasingly necessary and, as a result, that their ability to continue to prosper - and to benefit Canada and Canadians - is at risk.

-Some see a very direct trade-off between large Canadian domestic institutions becoming bigger and more internationally oriented, and the quality of competition in domestic markets.

-Some point to the present restriction on individual shareholdings in Canadian banks to 10% as critical to ensuring both a sound system and a Canadian controlled system. Others urge the elimination of this same rule on the grounds that it inhibits the growth of the sector by what they claim to be a somewhat crude protectionist measure from another, distant time.

We are also hearing that our regulatory system is throwing up barriers that disadvantage consumers by denying them choice.

-On the one hand, we are told that allowing banks to retail insurance and enter the auto leasing field would offer greater choice and lower prices to consumers.

-But we are cautioned that anti-competitive behavior based on increased market power may also result, to the detriment of existing suppliers and their employees and possibly to consumers as well, at least in the long term.

We are hearing from some that, on the whole, the financial services sector is serving Canadians very well - that it provides significant employment and is one of the world's most responsive systems to consumer needs.

Some contend that there are too many lower-income Canadians who do not have access to basic financial services and who have real difficulty in cashing cheques, even if drawn on a government.

There continue to be concerns about the availability of finance to small and medium sized businesses and knowledge based industries.

-There are growing worries related to privacy, particularly as financial institutions grow and expand their scope and as technology increasingly permits the storage and analysis of detailed personal data.

"It has ensured that our major banks continue to be Canadian owned. This pattern of domestic ownership of the banking system is a feature of all developed countries, even though they all are open to foreign competition. I also think that domestic ownership of clearing banks is important to the Treasury, Finance and central banking authorities around the world because of the importance of such banks to their economies and payment systems. Not one of the developed countries would allow any of their major clearing banks to be controlled by foreigners, even though there may be no laws in place to prevent a takeover. They will pass special legislation if administrative action won't work. This is certainly true of the US, the UK, western European countries and Japan. In my opinion, they are right to hold this position. Allowing foreign control of the banking system would seriously impinge on any nation's sovereignty."(unnamed treasury department offical.

"We have, I am convinced, the basic platform in Canada on which to build a strong financial services sector for the 21st century. We must however have the boldness to change, even to propose radical change, where it is needed. On the other hand, we must resist tinkering and succumbing to requests from any stakeholder which will not be for the greater national good. It will, no doubt, be a difficult balancing job. However, we see it as a vital one for our country and my colleagues and I on the Task Force and our staff will be working hard to achieve these goals."(Harold H. Mackay)

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