FINA Committee Meeting

STANDING COMMITTEE ON FINANCE

COMITÉ PERMANENT DES FINANCES

EVIDENCE

[Recorded by Electronic Apparatus]

Thursday, October 29,1998

• 1534

[English]

The Chairman (Mr. Maurizio Bevilacqua (Vaughan—King—Aurora, Lib.)): I'd like to call this meeting to order and welcome everyone here this afternoon. As everyone knows, the finance committee is studying the report of the Task Force on the Future of the Canadian Financial Services Sector. Today we have the pleasure to have with us representatives from the following organizations: the Canada Deposit Insurance Corporation; the Canadian Investor Protection Fund; and the Canadian Life and Health Insurance Compensation Corporation.

We will begin with the Canada Deposit Insurance Corporation, and we welcome Mr. Grant Reuber, chairman of the board, and Mr. Jean-Pierre Sabourin, president. Welcome.

Mr. Grant L. Reuber (Chairman of the Board, Canada Deposit Insurance Corporation): Thank you very much, Mr. Chairman. I'm very pleased to have this opportunity to meet with your committee.

We have passed around some material. It consists of three parts. One part is remarks that I will summarize in a minute. Secondly, there is a briefing paper that you have seen before. It outlines what we do and how we do it. The third paper gives a historical perspective in the sense that it more or less traces the history of how we got to where we are. I thought that might be a useful background in terms of your deliberations.

• 1535

“This is an era of turbulence in the financial services sector everywhere in the world.” The truth of this statement by the task force is even more evident from recent events that have forcefully brought to light the impact that instability or failure in one market can have in other markets.

Turbulence creates risks. Risk assessment is fundamental to an insurer. CDIC is far and away the major insurer of deposits held at Canadian financial institutions. Accordingly, in the time available, these remarks will focus on issues raised by the task force, with particular relevance to the safety and soundness of the system and CDIC's effectiveness as an insurer.

Before exploring these matters, I would like to acknowledge that the report from the task force represents a major achievement. It provides an excellent basis for reviewing Canada's financial services industry. The report attempts to provide a broad framework of policies, rules, and regulations for the financial services sector that the task force thinks will better adapt the sector to rapidly changing markets for financial services and will provide better services to Canadians.

Focusing on a broad framework has the advantage of ensuring that the larger picture remains clearly in view and is not lost in a plethora of detail. But in moving on to make decisions with respect to implementing the recommendations, it is necessary to dig into some of the details in order to assess the effectiveness and practicality of implementing particular recommendations. As always is the case, the devil is in the details.

From the point of view of a deposit insurer, the recognized turbulence of our times raises issues regarding the desirability of shaking up the system in order to try to make it more competitive, with whatever additional risks that may entail, and concurrently change the role and functions of the insurer. There are tradeoffs between some of the task force's objectives, such as increasing competition by various means, and existing objectives, such as ensuring the safety and soundness of the system and seeking to minimize exposure to loss.

The critical policy issues include identifying and assessing the significance of the various tradeoffs that will have to be made. For example, while allowing new entrants into the payment system may be a desirable goal, the basis on which that is permitted can make a major difference to the safety and soundness of the entire system, particularly if new entrants include enterprises beyond the reach of federal jurisdiction and functioning without government guarantees, such as mutual funds and investment dealers. Because of the absolutely central role of the payment system, some of the revised rules and regulations regarding entrants and perhaps the roles of direct versus indirect clearers may have to be worked out before fully revising other parts of the system.

Finally, before turning to more specific issues, I should like to underline the importance of a range of federal-provincial issues that arise at many points along the way to modifying the present system of regulation and compensation arrangements, which the task force does not specifically address.

Let me now turn to our two classes of recommendations that affect CDIC. The first are of a general nature, and then there are more specific proposals.

The first relates to holding company recommendations. Without disputing the possible benefits of holding companies, it should be pointed out that CDIC's experience with holding companies to date has not been free of difficulty. One major concern is how to contain failure in one part of the enterprise spreading to the insured section of the enterprise. The public frequently does not differentiate between a trustco and a trust company. Such contagion can considerably raise the costs of deposit insurance, and it further complicates the whole matter of dealing with failure when failure occurs.

A second question that comes up in this context is mixing commercial and financial ownership interests. In the past, Canada, the U.S., and the U.K. have largely avoided the ownership of banks by commercial enterprises on grounds of safety and soundness. In Canada, such ownership links have been permitted in the trust and loan company business.

• 1540

Commercial ownership links in Canada in the past have usually taken the form of a highly leveraged company owning a trust and loan company. While examples of successful linkages can be cited, Canadian experience with upstream ownership links for trust and loan companies in many instances has not been very successful. Since 1982, many trust and loan companies have disappeared, and virtually all were linked to commercial firms.

The third general provision or recommendation that I'd like to briefly comment upon is the subject of new entrants. The report proposes to stimulate more competition in the financial services sector by encouraging new entrants, especially in the deposit-taking business. To this end, it proposes to loosen somewhat the rules governing admission to the payment system, ownership restrictions, and so forth.

One obvious question is to what extent all deposit-taking institutions, or at least those admitted to the payment system, may seek to have comparable if not identical deposit insurance in order to level the playing field. If a life insurance company is going to be able to offer cheque writing and debit card facilities and is going to have deposit insurance, particularly through a government-backed scheme, what about an investment dealer in a mutual fund company wishing to offer the same facilities?

In this connection, it should be recognized that life insurance companies, investment dealers and mutual fund companies presently can—and some have—set up separate subsidiaries that have access to the payment system. What is being considered is a different form of access that may be easier and cheaper. It is interesting to note, however, that a number of small, independent trust and loan companies function quite successfully under present arrangements.

Let me now turn specifically to those matters raised by the report about deposit insurance. First there is the major organizational change that is proposed. The task force considered two proposals relating to CDIC. One was to amalgamate CDIC with OSFI. That proposal was rejected by the task force, as it has been by numerous earlier reviews of similar proposals, and I shan't comment upon it any further here.

The second proposal recommended by the task force is to blend CDIC and CompCorp under one umbrella, either as a crown corporation—which CDIC is now—or as an independent corporation without an explicit but with a virtual government guarantee of its liabilities. The proposal is based upon three premises: first, CDIC's role in securing the safety and soundness of the financial system is no longer very important; second, in protecting small depositors, because its liabilities are guaranteed by government, CDIC puts the products sold by a life insurance industry at a major disadvantage because the guarantee provided by CompCorp is not backed by the government; and third, federal and provincial jurisdictional issues can be handled without serious difficulties.

I suggest that all three of those propositions can be questioned. Let me look at them in turn.

On safety and soundness, in my view, CDIC continues to have an important role to play in stabilizing the financial system well beyond that of protecting the payment system. It provides a separate voice with its expert staff devoted to assessing and managing risk, its own priorities reflecting its financial exposure, and its own investigative and intervention powers, performance standards, and information sources when participating in the intervention process as companies move up the ladder from no problem to insolvent. As such, it provides an important and informed opinion on the intervention actions taken or not taken by OSFI or provincial regulators. It acts as a safeguard against both undue regulatory forbearance and arbitrary and unwarranted actions seen from the standpoint of minimizing the impact on losses to the deposit insurance system.

If competition is to be promoted as recommended by the task force, CDIC's role in this area will become even more important. The importance of CDIC having and making use of these powers was made clear in the findings of the Estey commission.

• 1545

In addition, because of its government guarantee, CDIC can assure the public that the dollar on deposit is the equivalent of the dollar in its wallet. That is to say, it can avoid runs on banks. Incidentally, in this morning's Globe and Mail, you may have noticed an article by Mr. Regule, in which he notes in the 1980s this deposit insurance provided considerable comfort in the case of the difficulties experienced by banks during that period.

Further, unlike the Bank of Canada, which for good and sufficient reasons is limited to making short-term liquidity loans, and then only on a fully collateralized basis, CDIC can lend on an unsecured basis and can provide guarantees. In the past, these facilities have been used as institutions have experienced difficulties. There's no reason to expect this function to be any less important in future, if as the task force proposes, new and different institutions are encouraged to accept deposits on an increasing scale to increase competition. What's more, removing or reducing CDIC's role in reinforcing the safety and soundness of the system would be inconsistent with CDIC's present mandate to minimize its risk of exposure for loss.

Let me turn to the second proposition on which this recommendation is based. The task force has accepted the view of the life insurance industry that they are at a significant competitive disadvantage in the market because CompCorp's insurance does not carry a government guarantee, whereas CDIC insurance does.

This alleged advantage for deposits applies only to a small portion of the products covered by CompCorp: deferred annuities with a term definite at five years or less, which are comparable to the GICs held by the banks. At present these make up, as far as I can tell, less on average than a third of the annuity business of the insurance companies, although I recognize that number switches around quite a lot in response to interest rate changes.

With the aim of levelling the playing field, the task force proposal would bring not only short-term annuities, but also many other products—annuities with a maturity of over five years, and retirement, health, disability, and death benefits—sold by the insurance companies under the same insurance arrangements as those applying to deposits, and would do so with either an explicit or a virtual government guarantee.

This represents a substantial increase in the financial exposure of the government. Moreover, it does not deal with levelling the playing field beyond the range of life insurance products to private pension plans, property and casualty insurance, and cash accounts and the deposits and other savings products available at investment dealers and mutual fund companies. This too would represent a substantial levelling of the playing field. It would, however, also increase the financial exposure of the government even further.

Here's a prime example of where the devil lies in the details. As already stated, there are important differences between the coverage afforded by CDIC for deposits and by CompCorp for life insurance products. In part these differences reflect the very different nature of the products. Life insurance products are perceived as being of a longer-term nature than deposits and they fulfil a very different function.

The task force proposal refers to one plan with parallel coverage. If the proposal is to be adopted, it would be necessary to define what constitutes parallel coverage. The big differences between deposits and insurance company products would need to be dealt with, as well as the differences in what is insured. I go on in my remarks on pages 14 and 15 to outline some of the significant differences. I'm not going to retail that list to you here—you can read it—but the main point of providing such a list here is simply to indicate that these and other issues will take considerable time to reconcile, and inevitably, not all the changes are likely to favour either deposits or life insurance products. If you really level the playing field, it's not at all clear the insurance companies would be any better off than they are today.

• 1550

For example, with insurance policies, your creditor can't attack some of the products, whereas a deposit in a bank is subject to a creditor. Another difficult issue is the problem of preferred creditor status, which CompCorp enjoys and which CDIC does not have. I won't go through the list, but there are significant problems to be resolved.

Let me turn to the third proposition or premise on which the task force proposal rests, namely that federal-provincial relationships can be harmonized. I've already mentioned this, and I want to emphasize again the complications arising from jurisdictional issues between the federal and provincial governments in many areas of the financial services industry. For example, in the foregoing list of differences between products insured by CDIC and CompCorp, several have important federal-provincial implications. Another example relates to credit unions, which are largely under provincial jurisdiction and in future may play an important role in increasing competition, as the report recognizes.

Over the years, ongoing arrangements and understandings have been established between CDIC and the Quebec Deposit Insurance Board and between CDIC and provincial regulators. The changes proposed might affect these arrangements and relationships and could bring additional federal-provincial issues to light.

So much for what is perhaps the main recommendation from the task force related to CDIC. Let me turn to two others.

The second one is the transfer of standards to OSFI. At present, responsibility for promoting standards of sound business and financial practices for CDIC-insured institutions is explicitly included in the CDIC Act. This combined with other responsibilities spelled out for CDIC to provide deposit insurance and to contribute to the stability of the system and minimize its exposure to loss was intended to provide a strong incentive for CDIC to take an active interest in the safety and soundness of the system and to take prompt corrective action if financial problems arose.

CDIC developed a set of standards in close cooperation with OSFI and provincial regulators. The standards adopted are widely acknowledged as being of a very high quality and have been emulated by others. The SARP, which is a short form for standards assessment and reporting program, is essentially a process whereby members assess themselves relative to the standards. Their self-assessments are acknowledged by their directors and senior management, and the whole process is monitored by OSFI and examiners of provincial members.

Both CDIC and OSFI believe that the benefits arising from implementing CDIC standards have been substantial, that the system runs smoothly, and that the criticism of wasteful duplication and cost is largely unwarranted.

SARP was developed to fill a gap in the information available to CDIC from OSFI. Assuming the substance of what is required by SARP is to be continued, one may question how the regulatory burden will be reduced by changing the reporting line from CDIC to OSFI.

On the other hand, there are two major advantages to leaving standards within CDIC's mandate. First, because the requirement to comply with standards and SARP emanates from CDIC, the requirement applies to provincial as well as federal institutions. If all references to standards were removed from the CDIC Act and transferred to OSFI, provincial institutions would no longer have to comply, unless required to do so by new legislation in each province.

Secondly, because the standards emanate from CDIC, CDIC's ability to deal with problem institutions is greatly strengthened. The same is true of its ability to take legal action in cases where CDIC suffers losses because of neglect or wrongdoing.

In my view, the present arrangements regarding standards are working well and there are clear advantages in leaving them under CDIC's jurisdiction.

The third suggestion from the task force is that in designing its system of risk-based premiums, CDIC would be limited to using only information available from OSFI. This reflects a complaint by the Canadian Bankers Association about information requirements.

• 1555

CDIC has a general policy of not requesting information from its members unless this is necessary to meet its responsibilities and is unavailable through OSFI or provincial regulators. Levying differential premiums is the responsibility of CDIC, not OSFI, and CDIC has to do its best to ensure that the differential premiums levied are fair and equitable.

The differential premium system was designed so that virtually all the information it uses is that which is currently collected by OSFI, although some information has to be adapted for insurance premium purposes. The remainder of the information is currently readily available at member institutions for their own purposes.

This proposal also fails to notice that CDIC looks only to OSFI for the information required and does not take into account that some of the CDIC members are provincial institutions, which are not subject to OSFI and would therefore not be reporting information to OSFI.

Levying premiums is similar to levying taxes; to be effective and efficient, it's desirable that accurate information be submitted directly by those paying the premiums to CDIC, which is now the case. Submissions on which differential premiums will be calculated will be required only once a year and will be based on a clear and well-understood format. After the initial data formats are established, the additional costs and effort to member institutions will not be very significant.

I will conclude, Mr. Chairman. The task force has marched to much the same drummer as in the Porter commission 35 years ago by emphasizing the need to increase competition, improve customer service, and open up the industry to new entrants and more enterprise, even if it means taking more risk with the safety and soundness of the system.

No one questions that there has been an enormous increase in innovation and competition in the industry over the past 35 years. It also seems clear that most of this was driven by developments in the marketplace at home and abroad.

If history is any guide, market forces are likely to be the prime determinant of the future of the industry. Only time will tell whether, as a result of the work of the task force and changes arising therefrom, Canada has made the most of rapidly changing market developments and opportunities through the public policies and practices it adopts for the industry.

As for deposit insurance, the task force's major recommendation is that the CDIC and CompCorp be combined. This recommendation rests on the assumption that the government guarantee now afforded to deposits via CDIC significantly affects the competitive playing field between deposits and short-term deferred annuities. This effect is important enough to warrant a major change.

However, one also has to pay attention to other differences in the playing field and where a change such as this may lead. Another factor is the attempt to assess the extent to which this proposal carries with it the potential for a huge increase in the government's financial commitments. It should also be recognized that life insurance companies at present can gain access to CDIC's guarantee by setting up subsidiaries. In addition, the proposed changes could seriously erode the effectiveness of CDIC's role in the safety net supporting the safety and soundness of the system. Finally, substantial questions remain about access to the payment system, the arrangements for closing failing firms, and federal-provincial relationships.

This type of proposal isn't new; it has been examined before. In each case, the conclusion has been that the present system reflects lessons learned, it's well understood, it runs well, it has not generated significant federal-provincial difficulties, and it serves the various requirements of the system reasonably well.

Let me add finally, though, that change is inevitable. There's little merit in maintaining the status quo for its own sake. It's important that deposit insurance arrangements be subjected periodically to scrutiny to ensure that their objectives remain up to date, organizational arrangements adapt to changing market realities, and incentives created are well aligned with policies serving the public interest.

• 1600

As the history of deposit insurance in Canada amply demonstrates, major changes have occurred during the past three decades in response to changing market conditions, growing experience, and successive policy reviews. It will be surprising if this process does not continue in the years ahead. There will always be the questions of what changes can be justified in terms of costs and benefits and when they can be most appropriately made.

Thank you very much, Mr. Chairman. Those are my verbal comments. I'd be happy at the appropriate time to try to answer any questions.

The Chairman: Thank you very much, Mr. Reuber. Thank you for the very useful package you provided to the committee.

I will now move to the Canadian Investor Protection Fund. Ms. Reszel is the president and chief executive officer. I welcome you.

Ms. Rozanne E. Reszel (President and Chief Executive Officer, Canadian Investor Protection Fund): Thank you very much, Mr. Chairman.

I will speak from my comments enclosed in the package you received. I'm very pleased to have this opportunity to provide comments to the standing committee on the report of the task force. I only recently assumed my role as president of this fund on September 1, 1998, so it comes at an interesting time.

These comments are my own; they do not necessarily reflect the views of the CIPF board of governors. I express them in the context of CIPF's two roles: customer protection and regulatory oversight.

I thought I would take just a short amount of time to acquaint you with the Canadian Investor Protection Fund. It's perhaps least familiar to those who are familiar with the compensation funds.

The primary focus of the MacKay report is federally regulated financial institutions and deposit-taking institutions. CIPF is a national fund whose member investment dealers are regulated by a provincial securities commission. As such, the securities industry is not directly addressed in the MacKay report other than by the recommendations relating to access to the payment system. However, a number of investment dealers are owned by banks and are part of financial conglomerates.

CIPF is a trust that was created in 1969. It is financed by the securities industry with a mission of fostering a healthy and active capital market in Canada by contributing to the security and confidence of investors who have accounts with our members of the sponsoring organizations that fund us. They are presently the stock exchanges of Alberta, Toronto, Vancouver, Winnipeg, and Montreal, as well as the Toronto Futures Exchange and the Investment Dealers Association of Canada.

The primary role of CIPF is investor protection, meaning the protection of customers within defined limits in the event of a member's insolvency. The secondary role of CIPF is the oversight of the self-regulatory system. The secondary role provides a mechanism to help CIPF contain the risk associated with its primary role.

The CIPF board of governors comprises twelve voting governors, including five industry governors appointed by the sponsoring self-regulatory organizations; five public governors; the chairman, who is the governor from the industry at large; and the president. CIPF has an authorized staff of nine individuals.

The provincial securities commissions, collectively called the Canadian Securities Administrators, or the CSA, have a memorandum of agreement with CIPF that covers areas of organization of CIPF, funding and maintenance of CIPF, client protection, financial and operational regulations, and reporting to the CSA. The CIPF chair and president report annually to a meeting of the CSA chairs, and the president reports as required throughout the year. We just recently completed our report to the chairs in Charlottetown two weeks ago.

CIPF protection is described in detail in the brochure and policy statements enclosed in your package. Briefly, the protection is $500,000 per account, of which $50,000 may be cash. Accounts eligible for coverage in a separate capacity, such as RRSPs, are specified in the policies. The protection does not include losses due to changing market conditions regardless of how they occur. Recommendations to increase CIPF coverage limits are presently before the CIPF board of governors.

CIPF is funded by the securities industry through regular quarterly assessments paid by members based on their gross revenue, risk premiums based on capital deficiencies, and an annual contribution by the SROs of interest earned on the fund balance.

Fund governors are permitted to assess members up to a maximum of 1% of their total gross revenues per year. The assessment rate is determined quarterly, taking into account the resources of the fund, industry conditions, and possible demands on the fund.

• 1605

The fund balance is currently $157 million invested in marketable fixed income securities, and the fund also maintains a $40-million line of credit with a Canadian chartered bank.

Since its inception, CIPF has paid customer claims of approximately $25 million net of recoveries from the estates of the insolvent companies, arising from thirteen insolvencies, the last in 1991. The full amount of CIPF protection is available for eligible claims after all available assets have been returned—and I've just referenced that to one of the background papers that did a comparison of that nature.

CIPF staff receive many customer calls and e-mails through our web site, all of which are logged and analysed for recurring themes and issues. Recommendation 26 in the report dealt with holding companies and the arrangement of subsidiary companies. In our industry, we certainly note that many questions relate to confusion concerning who the customers deal with, what they purchase, where their investments are held, and what protection the customer has if there's a problem or insolvency of an entity through which they purchased their investments.

Although there's an increasing convergence in the array of products that different financial entities are permitted to offer, customers seem to associate most strongly with the distribution channel, not the product. In each instance we try to turn the customers back to the basic questions.

First, with whom do they deal? We ask them to look at the documentation they've received. Corporate marketing names and corporate group names on advertising, stationery, and contracts obscure the underlying legal entities if they're not explicitly disclosed. Creative brand marketing, management and compensation arrangements have resulted in virtual entities; however, customers transact with a specific legal entity. Explicit disclosure of legal entities and the consistent application of disclosure rules are critical to permit consumers to make informed decisions. Many of the financial conglomerates wish to provide consolidated statements for clients. This will only exacerbate this issue unless a strict disclosure regime is enforced.

Second, what did the customer buy? A customer can purchase products that have the same economic result from each financial sector but are subject to different disclosure requirements. For example, a customer can buy a strip bond and equity index product from an investment dealer, an equity-linked GIC from the bank or trust company, and an equity-segregated fund with a guarantee of principal from an insurance company. While the complexity of prospectus disclosure for retail investors is currently the subject of review specifically as it relates to mutual funds, customers need clear and complete information to make informed decisions. Certainly recommendation 57 concerning clear and simple English legal documentation is one we would wholeheartedly endorse.

Third, where is the customer's investment? The extensive use of the Internet, telephone access to execute financial and security transactions, debit cards, credit cards, and non-certificated securities—including GICs and mutual funds—results in great efficiency for customers, but also in a need for customers to understand where things are and how they can be moved. GICs in the customer's name are branch-specific and cannot be transferred. Mutual funds registered in the customer's name are held at the mutual fund company regardless of the distribution channel through which the customer acquires them. Clear customer documentation must bridge the gap between the demise of the tangible paper product and the cyber-world we live in.

Fourth, what protection does the customer have if there is a failure of a financial firm with which they deal? CIPF, CDIC, and CompCorp each offer protection to customers of a different nature. CIPF protects the existence of the customer's assets, but not their value if a member becomes insolvent. A customer of CIPF may also hold CIDC-insured deposit instruments or a CompCorp-insured insurance product in his or her account and also be eligible for protection through these compensation funds in the event the issuer of the deposit instrument or insurance product becomes insolvent. I think this—the nature of the coverage—is an interesting distinction that we find cropping up most often. Each compensation fund conducts its own public information and customer education programs, and recently the three funds have met to explore whether a joint communication to the public could also be developed.

• 1610

The opportunity for financial institutions of all types to offer a broader ranger of products increases the need for highly trained and qualified individuals. Training must be a continuous process to keep pace with the rapid change in complex products. The securities industry is committed to maintaining a high standard of professionalism through its education and proficiency standards, and the SROs are considering implementation as mandatory continuous professional development in 1999.

I'd like to touch briefly on regulatory oversight. The self-regulatory nature of our industry is worth commenting on with respect to the three components of self-regulation. Member firms are active in the business and propose the rules subject to regulatory oversight. The disciplinary process involves peers who know the business and the risks. Members are accountable to their peers, because if there's a failure, the cost of protecting customers is borne by the other members.

We have found that self-regulation has balanced the need for prudent capital requirements and competition. This is evidenced by the growth in number of firms. There are currently 188 members of CIPF, compared to 120 in 1990. Of the 188 firms, 115 have fewer than 50 employees.

Many new entrants utilize the category of membership called “introducer”. Introducers focus solely on the customer side of the business and contract with other firms called “carriers” for trade execution and administrative and operating support. Carriers have a substantial investment in processing, operations, and administration and sell their excess capacity to introducers.

In order to manage the risk to the fund, CIPF governors specify the minimum standards of the fund for its members, which include: capital adequacy and liquidity; financial reporting; accounting records; segregation of customers' fully and partially paid securities; insurance; internal controls; and the early warning system. The minimum standards are enforced by the SROs through their bylaws and regulations.

CIPF's role is not to duplicate the work of its SROs, but to complement it and be a resource to ensure consistent application of the fund's minimum standards. CIPF receives and reviews monthly regulatory filings from all its members and analyses industry results, looking for trends and anomalies.

The annual audited financial questionnaires are addressed to CIPF as well as the SRO. CIPF staff perform field examinations of members on a rotational basis. Some might liken us to the internal audit department for the industry.

A financial conglomerate, which includes a bank, a trust company, an insurance company, and an investment dealer is subject to three different capital calculations. If there is a financial failure in a conglomerate, three compensation plans may be involved.

The desire of banks, trusts, insurances companies, and investment dealers to consolidate the processing of related financial companies highlights the critical need for firewalls between each of the companies. An incredibly complex situation would result in the event of a failure of a conglomerate with totally consolidated operations.

For example, the Winding-up Act does not include a provision for allocating shortfalls and securities held for customers, and part XII of the Bankruptcy and Insolvency Act, which does, applies only to securities dealers. Firewalls to ensure that each regulated entity meets the requirements of its regulatory regime minimize the risk of contagion.

Financial conglomerates highlight the need for uniform capital requirements for similar financial instruments. Traditionally, the securities industry capital requirements have focused on market risk, banking capital requirements on credit risk, and insurance capital requirements on actuarial calculations of risk. However, the increased convergence of product and business lines introduces the risk of regulatory arbitrage if there are substantial differences in capital requirements.

In conclusion, I'd like to say that the significant amount of work done by the task force is evidence of the complexity of changing regulatory frameworks, and we welcome the opportunity to participate in the dialogue.

Thank you very much.

The Chairman: Thank you very much, Ms. Reszel.

Now we'll hear from the Canadian Life and Health Insurance Compensation Corporation, Mr. Alan Morson and Gordon Dunning. Welcome.

Mr. Alan E. Morson (President, Canadian Life and Health Insurance Compensation Corporation): Thank you very much, Mr. Chairman, for the opportunity to appear before your committee this afternoon.

I'm the president and CEO of CompCorp, and Gordon Dunning is the executive vice-president, and we will both take part in our brief presentation, if we might. Our presentation is the one with the buff-coloured front page.

We believe the task force has produced a thoughtful, comprehensive overview of the financial services sector and the challenges it faces in a rapidly changing global financial services market. Within this very broad overview, the task force identified several issues in relation to Canadian consumer protection in the event of the insolvency of a financial institution. That is why we are here today.

• 1615

The task force acknowledged that consumer choice of product should not be influenced by the different levels of government support provided to an industry's compensation corporation. It recommended levelling this competitive playing field. The task force recognized the increasing trend towards both industry and product convergence and the need for compensation corporations to respond to this trend.

It also focused on the current customer confusion on the existence of consumer protection, the level and limits of that protection, and the identity of the provider of consumer compensation for any particular product in the marketplace.

After identifying these issues, the task force went on to consider specific solutions. It recommended two potential models as solutions. In so doing, the task force made reference to the continuing different nature and the extent of risks associated with life insurance companies and deposit-takers. However, the task force did not place particular emphasis on this aspect; rather, it focused on the similarities. We believe that this particular issue requires more thoughtful study during the next phase of implementing changes to the compensation corporations.

Detailed consideration should also be given to the appropriate level of federal government involvement, provincial government involvement, and industry involvement in the plans. In addition to the two models recommended by the task force, the CLHIA in their submission recommended a third model.

As a major player in consumer compensation, we felt we should comment on both the issues raised and the solutions suggested. At this stage it seems appropriate to assess the validity of the issues raised and affirm the need to address them. Before making any decisions, however, as to how to change or combine the compensation corporations, we recommend that further detailed work be done by knowledgeable plan, industry, and government representatives as to the best way to address the issues raised by the task force in light of these and some other relevant issues.

I'd now ask Gordon Dunning to comment directly on the issues that have been raised by the task force and then I will comment on a couple of additional issues.

Mr. Gordon M. Dunning (Executive Vice-President, Canadian Life and Health Insurance Compensation Corporation): Thank you, Mr. Morson.

The first issue I'd like to comment on is the question of the level competitive playing field. CompCorp fully supports consumers receiving the same level of government support in the event of an insolvency, regardless of the type of financial institution that fails.

Currently, consumers who purchase their products from deposit-taking institutions receive both a government guarantee of protection and almost immediate access to their funds on insolvency. This access is achievable because of the liquidity support the government provides CDIC. Life policyholders enjoy neither of these benefits. This inequity has not resulted in reduced protection to policyholders up to this point. CompCorp has in fact successfully met all of its obligations in the three insolvencies it has faced.

Confederation Life consumers did have restrictions placed on some of their funds, but the impact of this was alleviated by the adoption of a hardship committee. Such a committee was set up in all three insolvencies. In a different interest rate environment, i.e., one in which interest rates are rising rather than falling, the task of satisfying policyholders' demands for their cash would undoubtedly be more difficult. The availability of liquidity support from the consolidated revenue fund would facilitate a greater consumer choice and access to their funds.

Despite our past successes, the general public still perceives CompCorp's insolvency protection to be second-class coverage. It is therefore a very important competitive issue both for consumers and the industry.

We believe that the same level of government support should be available to both deposit-taking institutions and life insurance companies. While we do not advocate any particular level of government support, consideration of models that reduced government support would be entirely consistent with the direction of public and government attitudes.

• 1620

I would now like to turn to the problem of the convergence of industries. The task force highlighted the problems associated with the convergence of industries and the potential difficulties associated with the insolvencies of a conglomerate. When a company has more than one type of financial institution, there is therefore the involvement of more than one compensation corporation. This is an ever-increasing potential problem. If a financial conglomerate were to fail, poor bookkeeping—which is typical in insolvent companies—and assets in transit may blur the ownership of assets between members of the group. It may be difficult to establish which assets belong to the life company, the bank, the trust company, the mutual funds company, or the property and casualty company.

We endorse the task force's concern and believe that if this issue is to be properly addressed, further studies should encompass not only the deposit-taking institutions and life insurance companies, but mutual fund companies, investment dealers, and property and casualty insurers. The merger of CompCorp and CDIC is clearly not the only way, and likely not the best way, of addressing this particular issue.

I'd like to now turn to the other convergence issue raised and that's the convergence of products. The task force correctly identified the important overlap between the products issued by life insurance companies and the products issued by deposit-taking institutions. This overlap may in fact continue to increase as the products in both types of institutions evolve.

The task force, however, did not place much emphasis on the life insurance, disability insurance, and life annuity products, which are sold only by life insurance companies and are unique to our industry. They even require very special consideration on insolvency. The consumers of these products require continuation of coverage rather than cash compensation. They must continue to pay their premiums into an insolvent company in order to retain their life coverage. This fundamental difference substantially changes the liquidation approach between the two types of financial institutions.

The approach with deposit-takers is to liquidate the assets and pay out the claims. The approach in insurance is to discontinue sales activity but to continue the operations. This allows for the continuation of coverage for consumers while we seek new carriers and the continuation of investment operations to work out the long-term assets that are typical in an insurance company.

Now I'd like to talk about consumer confusion. The task force also raised an important issue when it identified confusion in the minds of consumers as to which corporation covers which product. This confusion not only exists between deposit-taking institutions and life insurance companies, but spreads across investment dealers, mutual fund companies, and property and casualty insurers.

One of our current concerns is to ensure that consumers understand mutual funds are not covered by any compensation corporation and that segregated fund coverage by CompCorp is limited to the guarantees provided by the life insurance company. These are communications issues, which we have commenced working on with the other protection plans.

I'd also like to highlight the life insurance risks as compared to the deposit-taking insolvency risks. The task force recommended the continuation of two assessment pools within the combined organization, one for deposit-taking institutions and one for life insurance companies. This was done in acknowledgement that the insolvency risks and costs faced by the two sectors are different. CompCorp has developed expertise in monitoring the insolvency risks of life companies, and, as just outlined, we've also developed special procedures that are needed to continue policyholder coverage should an institution fail.

If healthy lives take their business elsewhere, leaving only unhealthy lives in the insolvent company, the averaging principle of insurance is frustrated and the cost of failure increases. The ability to manage these specific risks must be retained in any new form of compensation corporation that is subsequently developed.

Thank you, Mr. Chairman. I'd like to now turn back to Mr. Morson.

Mr. Alan Morson: Thank you, Gordon. I have a couple of other considerations, Mr. Chairman.

Having agreed upon the basic issues that should be addressed, as the task force has, there are two other issues that are not considered in the report that must be kept in mind in determining the best way to move forward to implement solutions.

The first of these is the advisability of a federal plan versus a national plan. In life insurance, while solvency is primarily a federal concern, consumer protection and contractual considerations are under provincial jurisdiction. CompCorp bylaws require the agreement of all 13 jurisdictions in Canada—10 provinces, two territories, and the federal government.

• 1625

The basis for sharing the risks and costs of coverage is national, that is, it is spread right across the nation. In the final model that is agreed to, this is both the fact and a strength of the existing plan that must be recognized in moving forward.

The second consideration is the degree of involvement of industry. While some form of ultimate government support may be required to provide the confidence considered necessary for consumers and to deal with the unlikely but possible systemic risk, there should be an important role for industry to play. This role is required not only to ensure that the plans remain relevant to the ever-changing products and risks involved in the different financial services, but also to minimize the cost to policyholders and depositors who'll be expected to bear the cost. The greater the degree of industry involvement, the less the requirement for the bureaucratic costs that necessarily accompany government involvement. At all levels of government, ways are being sought to reduce government involvement.

In conclusion, Mr. Chairman, we believe the task force has performed a valuable service in identifying issues of consumer compensation that need to be addressed and in putting forward two potential solutions. We urge the committee to recommend acceptance of the level playing field proposal and the further study of the most appropriate way to address this and the related issues of institutional and product conversion and consumer confusion. There are a number of models that could address these issues, and we at CompCorp are anxious to participate in any such future discussions of the most appropriate solutions.

Thank you, Mr. Chairman. We'll be happy to answer any questions you may have.

The Chairman: Thank you very much, Mr. Morson and Mr. Dunning.

We will now proceed to the question and answer session with a fifteen-minute round, beginning with Mr. Harris.

Mr. Dick Harris (Prince George—Bulkley Valley, Ref.): Thank you, Mr. Chairman, and thank you, ladies and gentlemen, for your presentation.

My first question will be to Mr. Reuber and Mr. Sabourin from CDIC. Am I to understand that this is the year you're going to retire your debt, or is it next year?

Mr. Grant Reuber: We retired all our debt last July.

Mr. Dick Harris: So in this next fiscal year we'll expect a surplus in your reserve fund. Is that correct?

Mr. Grant Reuber: No. We're going to reduce premium rates, or at least we plan to reduce premium rates. The board of CDIC adopts a policy that it takes full provisions against all our risks, and that includes every institution that is a member of CDIC. Having taken full provision against those risks, the need for a surplus is no longer apparent. Consequently we can reduce the premium rates so they will pay current costs but do not build up a surplus.

Mr. Jean-Pierre Sabourin (President, Canadian Deposit Insurance Corporation): I would just like to add one point. As the chairman pointed out, the debt to the CRF was fully repaid in July, as we've provided you in our document—about $7.6 billion plus $1.4 billion of interest. But this year we will also eliminate the deficit. Looking forward, we've set up a general provision for a reserve for future losses. So the debts were paid in July, the deficit will be eliminated this year, and we will have a reserve for future losses.

Mr. Dick Harris: What do you mean by a reserve for future losses? Are you talking about a reserve fund against future losses?

Mr. Grant Reuber: It takes the form of a specific provision against every institution that's a member of the CDIC. Add it all up and you get the total provision for loss. That's the fund we're talking about.

Mr. Dick Harris: Okay. What kind of dollar figure are we talking about?

Mr. Grant Reuber: I think it's something in the order of $400 million this year, but that will be adjusted every year.

Mr. Dick Harris: Okay. So this year your full provision for future losses is estimated at $400 million. Is that correct?

• 1630

Mr. Grant Reuber: Right. Plus, of course, we would have annual premium income we could put up as required to meet financial requirements.

Mr. Dick Harris: Is this assessment of future loss an annual review?

Mr. Grant Reuber: Yes.

Mr. Dick Harris: How many years ahead do you look?

Mr. Grant Reuber: There are two categories of institutions. One is those that are sort of on the watch list, if I can put it that way. We have a fairly intensive process of examining them and trying to estimate in the traditional way what our losses are. Then there is the whole range of institutions that are not on our watch list. We base the reservation on the differential paid in the market between the interest they pay on their bonds and the Standard & Poor's rating—based on the Standard & Poor's rating and the Government of Canada. So if there's a differential for bank X of a certain amount, we apply that as a measure of the risk.

Mr. Dick Harris: If I can recall, you currently have about $550 million a year in premiums coming in. Is that correct?

Mr. Grant Reuber: That's correct.

Mr. Dick Harris: Okay. Did you just say your provision against future losses is about $500 million currently?

Mr. Grant Reuber: It's about $400 million this year. It was $500 million last year and may go up next year. I can't predict that.

Mr. Dick Harris: Is it expected that you could increase that provision next year?

Mr. Grant Reuber: It's possible. We haven't done the review. We will do that toward the end of the fiscal year and at the end of March. If because of changes in the current economic situation circumstances are such that it calls for an increase, then we will increase it.

Mr. Dick Harris: Okay. I guess what I'm getting at is if the annual premiums based on current assessments are $500 million a year and your provision against future losses is about $400 million to $500 million, basically the only costs your members are looking at next year, if the provision doesn't go up, are the operating costs of CDIC. Is that correct?

Mr. Grant Reuber: It will be a little more than that, because we can't just get in dead level at zero. So we will probably come in at a bit more than that. We will also have to be concerned about what the level of reservations will be.

I've outlined the general approach to it. Exactly how those numbers will work out I can't tell at this juncture, but that's the idea.

Mr. Dick Harris: I think the total of claims, if I can put it that way, CDIC has paid out in its history is about $5 billion. Is that correct?

Mr. Grant Reuber: Losses.

Mr. Dick Harris: Right.

Mr. Jean-Pierre Sabourin: The claims we paid are close to $25 billion—that we protected in one form or another.

Mr. Dick Harris: I'm just wondering why you wouldn't build up a reserve fund to $5 billion or $6 billion.

Mr. Grant Reuber: We have taken the view that if we have provided in a reasonable way—we think we have—for the provisions, and given our capacity to tax the institutions, we don't see it's necessary to build up a large reserve. In a sense that's just taking money away from the institutions and putting it into our own coffers, and there has to be a reason to do that.

Mr. Dick Harris: One reason to do it is if we have a bank failure and there's a considerable loss and you have to then try to borrow the money from the federal government, from consolidated revenue or the market, you will end up paying interest on that money. This might be simplistic, but I thought maybe building a reserve fund and having it invested in an interest-bearing fashion could prevent the necessity of future borrowings in the event of a loss.

• 1635

Mr. Grant Reuber: Under the arrangements implemented about two or three years ago, our first borrowing will be from the marketplace; it will not be from the government. That will, obviously, be based on our ability to tax the institutions. So we don't think that's a big problem with raising funds.

Secondly, on all of our borrowings we pay a premium to compensate for the government guarantee. It's a matter of judgment where you draw the line and, if you're going to build up a fund, how big the fund should be. We thought it would be preferable—this is a board decision—to base the fund on the notion that the reason there is a fund is to ensure against the risk and to put the emphasis on assessing the risk and getting the fund to reflect that, rather than having a sort of arbitrary number that's pulled off the wall and is very difficult to justify to our members. We can justify our numbers pretty well to the membership now.

Mr. Dick Harris: I was just suggesting the best time to build up a rainy day fund or contingency fund is when things are going pretty well, and things are going pretty well right now.

Mr. Grant Reuber: I don't dispute that for a moment, but we think we've done that through this provisioning arrangement.

Mr. Dick Harris: The proponents of a national cooperative bank of sorts have recommended to our committee in Vancouver that perhaps deposits should be insured up to $100,000 in their proposed national cooperative bank. I guess that's justified on the grounds that credit unions offer guarantees that are often more generous than the CDIC limits.

I have a couple of questions. Do you think it's appropriate to implement some sort of two-tiered system of deposit insurance, with higher limits for a co-op bank and maybe lower limits for a common institutional bank as we know it, or do you think maybe the limits could be raised to $100,000 for all CDIC members?

Mr. Grant Reuber: On the first question, you can make a case either way. My own preference would be to have the same general arrangement. As you know, some of the co-ops have no limit in some provinces. I think you should also recognize that under present arrangements you can stack deposits through various institutions and within the same institution. So we've really had very little pressure to increase the limits, and I think it's because of the stacking option.

I don't have any great particular problem with raising the limit to $100,000, since I don't think it's going to make much difference because those who want to get insured for that amount are already getting it one way or another. I would hope, however, if it is done there could perhaps be reconsideration given to the notion of some co-insurance for the additional amount that's added on. I haven't raised that issue here. It was discussed pretty thoroughly two or three years ago and was fairly firmly turned down by the government. Then the proposal, as it came from the Senate, was that there be full insurance for the first $30,000, I believe it was—whatever the number was—and the remainder would have a 10% co-insurance feature. I would hope if you went to the larger number you're talking about, that might be reviewed as applicable to the step up.

We've talked to the co-op people, and we're willing to accommodate as best we can any arrangements they wish to raise with us. This is not a show stopper on the deposit insurance at all, as far as I'm concerned or anybody else.

Mr. Dick Harris: Thank you. Do I have any time left?

The Chairman: Yes, you have three minutes.

Mr. Dick Harris: I want to thank Mr. Morson and Mr. Dunning and all of you for the great information you've given us today. CompCorp is basically, as I understand it, an insurer within the industry you represent.

Mr. Alan Morson: That's correct. We are effectively owned by the member companies. As opposed to an insurer, we have a bit of a pre-fund, but rather than paying insurance premiums we collect money from the industry as we require it.

• 1640

Mr. Dick Harris: Okay. So if there's a loss of some sort, you would go to your members to pay out that loss.

Mr. Alan Morson: We would assess them for it; that's correct. But we do have a pre-fund, some rainy day money.

Mr. Dick Harris: That was $500 million. Did I read that right?

Mr. Alan Morson: That's correct.

Mr. Dick Harris: Is it my interpretation of your presentation that you want to somehow get involved with CDIC, or you want to see CDIC become an insurer like yourselves? Exactly what relationship are you looking for?

Mr. Alan Morson: Effectively, what we were saying is we think the issues that were identified are important ones and something should be done. But there are a number of different models, and we should be sitting down with CDIC, with government officials, and with industry people and coming up with which model is the best to go on.

Mr. Dick Harris: In other words, you're suggesting perhaps in one model your group of members could be merged under the CDIC program, or maybe vice versa, or a combination of both. Is that—

Mr. Alan Morson: Yes, and there was a model put forward by the industry that effectively looked for a reduction in government guarantee to CDIC and having then a government liquidity authority so that either CompCorp or CDIC could then go to that liquidity authority. If it required money for liquidity purposes or if there were some systemic risk, then there is a path there to provide whatever funding may be necessary.

So there are a number of different models, because there are a number of issues. I think the task force saw these two models as potential solutions, but there are also some difficulties with them, and we need to sit down and talk about the ways.

Mr. Dick Harris: Okay, thank you.

Ms. Reszel, you provided a wealth of information on your organization, but unless I missed it, I can't see any recommendations or exactly what you're asking for.

Ms. Rozanne Reszel: We weren't particularly asking for anything. What we did was take the report and try to identify those things where we thought we could make a contribution, based on what goes on in our industry.

Interestingly enough, because we are owned, created, and financed by the industry, we do pre-fund, as I mentioned. We are also clients of the constituents of the other two funds in that we maintain a line of credit with a Canadian chartered bank on commercial terms in the event we needed those resources. We also explore alternative resources for those circumstances where we might have larger demands made on us than we have pre-funded for, with insurance companies, to determine if there is a third-party insurer that would like to look at excess CIPF insurance.

There is in fact a market that looks to our member firms to provide them excess coverage, beyond what we cover, from independent third-party insurers. So we also look to that as a potential resource for our industry.

The issue of a government guarantee hasn't been on the table or hasn't been discussed by our board, so I'm really not in a position to speak to it in that context. But clearly, inasmuch as we all make an effort to review all the resources that might be available in the event of a calamity, that would certainly be an interesting discussion to pursue.

Right now we rely on the fact that in the event of a serious loss we could assess up to 1% of gross revenues. Based on revenues last year, that would potentially see us calling for about $80 million. So we've pre-funded to the extent of $158 million, but in our 30-year history our total pay-outs have totalled, less net of recovery, less than $25 million.

So we've pre-funded about six times that, we have the additional $40-million line of credit, and we're certainly not looking to tempt the fates, but we've been very fortunate of late to have had changes in the Bankruptcy and Insolvency Act that go to determining the distribution of assets on an insolvency using a pooling method, as opposed to the specific identification and tracing method that used to be in the old legislation.

So it has considerably reduced the risk of there being a very large loss to any one individual client, and it has in fact put into the pool of assets that would be available to be distributed to clients all of our firm's bank accounts, all the firm's inventory, all clients' securities, and any investments or realizations on investments in subsidiaries. We feel that has been a major move forward in terms of providing protection to investors and customers of our firms, and it also goes a long way to mitigating any risk of a disastrous loss for any one individual.

• 1645

Mr. Dick Harris: Thank you very much.

The Chairman: Now we'll go to Mr. Szabo, followed by Mr. Discepola, and then Mr. Valeri.

Mr. Paul Szabo (Mississauga South, Lib.): Thank you, Mr. Chairman, and thank you to all. I never cease to be amazed at how complex this industry is—I'm referring to the financial services sector. I can tell you over the last couple of weeks more and more spectres have been raised, and you're continuing to add to the list. I'm wondering what's happening to your temperature when you consider the prospects.

One example was the former Superintendent of Financial Institutions who raised, quite simply, the whole issue of the risk of the Y2K problem, the millennium bug problem. This is one of those things that potentially could cause some difficulties, and I'm wondering whether or not your organizations have satisfied themselves that our financial services sector, without any substantive changes, is going to be ready and whether that in itself is not a serious risk-management issue.

Mr. Grant Reuber: We have given a fair amount of attention to that issue. Within CDIC we think we'll be fully compliant. We have a fairly substantial program running and we think that's not the issue. The issue is the industry in a larger frame, and that has been given a lot of attention, particularly by OSFI, so you may wish to speak to them about it.

I can give you my impression from that discussion. I think the banking industry, generally speaking, has done a lot of work in that area and I have reasonable confidence we will be compliant.

The problem is their customers, and there's no clear answer, to be honest. We think they are, as I understand it, applying through their credit reviews and, as they examine customers' arrangements, taking account of their compliance with the requirements. But I would be the last to guarantee you a trouble-free ride on January 1, 2000 in this area.

The question is of course whether there are critical areas. It's highly unlikely the whole world is going to be 100% compliant on January 1, 2000. The question is whether everyone has identified those particularly critical areas that really do make a big difference. There is a lot of work going on on that, but I would suggest you raise that issue with Mr. Palmer when he shows up. He's been more directly involved.

As far as one can have a view at all, we believe the situation is reasonably well in hand as far as the institutions themselves are concerned. And both the institutions and the regulator have, I think, extended their view beyond just those institutions to the customers.

Do you want to add a word?

Mr. Jean-Pierre Sabourin: I have two points, Mr. Chairman. As far as Y2K is concerned, we're aware that the Superintendent of Financial Institutions has issued guidelines to all of the institutions in that regard, so Mr. Palmer will be able to speak to that.

As part of our SARP process, which, as our chairman pointed out in his opening remarks, is the standard assessment reporting process, we've asked institutions to report to us this year on where they are in regard to Y2K, what work they have accomplished, and what concerns they may find.

Both CDIC and the regulator are certainly on top of the issues of Y2K. The impression we're getting is that the banking industry certainly has taken this as being an important area and they are spending a lot of money, time, and effort in getting things done. As the chairman pointed out, there is the issue of customers, and obviously they're doing that through their credit-risk assessment.

• 1650

Mr. Paul Szabo: The second area of risk management for me was raised by the Governor of the Bank of Canada with regard to the complexity of making changes to the payment system. His assessment was that as you start to make these changes, his ability to administer monetary policy starts to become a little less certain, and this caused him some concern. I'm not sure if you have a comment there.

You might want to blend this last thing in if there are any comments you have. It has to do with the prospect of bank failures. For the first time, someone actually said that, from their best assessment, we should not discount the fact that under a restructured, opened-up financial services sector there's the possibility that failures will in fact occur.

Even Mr. Godsoe, who was here this morning from the Bank of Nova Scotia, was talking about things like new regulations and how they may be a barrier to new entries. New entries may try to get in and start to play and move up from the minor leagues to the major leagues, but they won't have the kind of stability in those early years to be able to deal with all the complexities that are going to be thrown at them.

From the context of risk management, do you have a sense that maybe there's a strategy of chunking this whole process of restructuring the financial services industry so that building blocks and foundations are in place? What comes first? Others have suggested that MacKay's report is kind of a comprehensive approach that has some synergies and some linkages and that we should basically start looking at moving forward without too much cherry-picking.

Mr. Grant Reuber: That's a large question you ask. I'm not sure I'll give you a very satisfactory answer, but let me at least give you some comments.

On the payment system, I agree entirely with the governor. I think that's at the core of the system. We've dealt with the large value part of that. We're now on what we call the paper part of it, which in some ways is equally complicated. It doesn't have transactions that are as big in some ways perhaps, but it's equally complicated.

We have a good payment system: if you put a cheque in the bank today, you get money today. You don't have to wait two weeks to get credit for it. So there are many features of the current payment system that work extremely well.

If you open it and change the rules by letting new players into the game—investment dealers, mutual funds, and insurance companies are the ones normally mentioned—there are all kinds of things that have to be worked out. Those institutions, by and large, don't have access to the Bank of Canada discount system. There are a whole lot of other questions. Creditor priority, for example, in the insurance business makes quite a difference in terms of fitting them in, as does policyholder priority.

I won't profess to tell you how that should all be done, because I don't know. A lot of work has gone on, but it's not a slam dunk kind of thing in terms of just going and doing it. It's a very complicated issue.

I would like to emphasize again the point I made in my brief, however, that those three institutions—that's insurance companies, mutual fund companies, and investment dealers—can all get into the payment system right now by setting up subsidiaries. They would argue that this is complicated and so on, but in fact we have small, independent trust companies that do quite well.

So it's difficult to sort of assume that it's such a great obstacle and so difficult. There are lots that didn't do so well too, I know that, but it is feasible to be a profitable small trust company in this business and be part of the payment system.

• 1655

The question of the prospect of bank failures is again a very large question, and certainly we think we try hard to keep a view of that. There's no doubt the world is a more dangerous place today than it was perhaps a year or two ago as far as the viability of financial institutions is concerned. I think it's also possible that as you allow new entry, and raising the risk somewhat—that's how you're supposing to get these new entrants—you do take on more risk, and that may in fact generate somewhat more failures.

But as far as the broad picture of banking in this country is concerned, I really believe the system today is quite secure and quite sound—in my judgment, in a much stronger position than it was, say, in the 1980s. They're making more money, for example. You have to have a profitable system to be a sound system.

Secondly, a fair number of the weaker institutions have been weeded out. I believe the peak of our membership was in 1983 when we had 188 members. Today we have 112 members. Not all of them have failed. Many have gone into amalgamations of one kind or another, so there has been a considerable consolidation of some of the smaller institutions and presumably, in many cases, weaker institutions.

No good system is a risk-free system, though, so—

Mr. Paul Szabo: Let me ask you one other final quick question. It's something that came up about a year ago. It was an issue I had been involved in. It had to with restrictions on bank board members and the number of directorships they could hold, and so on, those kinds of issues where you get into risk-management areas and you see the governance issues becoming more and more in focus.

In the U.S. it appears they're getting concerned about the concentration of board memberships and cross-directorships, as well as the elevation of marquee directorships, where the participation rates are lower. These are also fundamental risk elements since that's where decisions are being taken.

That issue of governance doesn't seem to be a major component of MacKay. Is that of concern to you at all?

Mr. Grant Reuber: No, I don't think it is. Given all the other risks you can worry about, I would put that at a lesser level than some of the other questions.

I might add a point there. In our standards assessment program, the board of directors each year has to pass a resolution indicating that the institution is in conformity with the standards, or if they aren't, they have to outline the deficiencies and how they're going to fix them. We think that has brought a lot of clarity to the directors, because they're now signed on the dotted line as saying they conform with those standards. I think it's without question that before they're willing to pass such a resolution, directors have asked to be much better informed about various parts of their activities, such as real estate appraisals, to give you one example. In some cases, banks have considerably revised their procedures.

I think we've made some progress on that front. I can't talk specifically to the question of conflicts of interest between directors. I think they all now have a special committee that deals with these matters, and I don't see that as a primary problem as far as the financial institutions are concerned. I believe our standards have brought a greater sense of responsibility to board members in the sense that they now have to sign on and say, yes, as a director I am satisfied that this institution is meeting acceptable standards of conduct.

Mr. Paul Szabo: Okay, that's helpful.

Thank you, Mr. Chairman.

The Chairman: Thank you, Mr. Szabo.

Mr. Discepola.

Mr. Nick Discepola (Vaudreuil—Soulanges, Lib.): Thank you, Chair.

• 1700

Mr. Reuber, the doctrine of “too big to fail” intrigues me, because the more I look at it, the more I hear testimony— Even the governor of the bank yesterday admitted that in the final analysis no system is risk free and that there could be failures. In the event of a successful merger, what is the role of your institution in the event of a failure? Who would ultimately end up picking up the costs of such a failure? Do you have a role in that or is it ultimately the responsibility of the Canadian taxpayer through the government?

Mr. Grant Reuber: Our role would not change if it were simply a failure. Let's say institution A and institution B merge. We already have a provision on institution A and a provision on institution B, and that provision would now be merged on those two institutions. Even if you took one of the very large banks today, a failure would be a major difficulty, given our resources. We're permitted under our present authority to borrow up to $6 billion. That would be pretty skinny, wouldn't it, if you were talking about the failure of one of the biggest banks in the country?

Mr. Nick Discepola: What's the difference?

Mr. Grant Reuber: We go to see if we can get the ceiling lifted, but I think there's not much doubt that resources would have to come from somewhere.

I want to make a point about “too big to fail”. That was something that came to light when the Continental Bank of Illinois failed in Chicago sometime in the 1980s, I think. I think it's important to distinguish between the notion of failing from the notion of loss. It's quite possible to have a failure with very little loss. The question is, if you deal with the problems before all the equity is drained away— even a small company, because of the high leverage in the banking business, can be very expensive if you simply let the equity drain away before you do anything.

I think the regulatory arrangements in this country, particularly OSFI's activities, are really quite effective, and so the notion that just suddenly the whole thing is going to collapse some morning is not really a very realistic picture, although it conceivably could happen. But I think long before that final doomsday scenario arrived, OSFI would have been doing a lot of things through its inspections and so on to ensure that it didn't happen.

Mr. Nick Discepola: What about the associated notion of banks taking added risk knowing they won't be allowed to fail, especially with depositors' insurance. Should extra precautions and demands be made on the banks, as Mr. Harris said, to increase the $60,000 deposit insurance? I know you said it doesn't seem to make a difference.

Mr. Grant Reuber: If you increase the amount, you will increase the moral hazard; you won't diminish it. The logic of the moral hazard argument would be essentially to say that if you reduced the amount of coverage, it would diminish the risk and banks wouldn't rely so much on the deposit insurance system.

As I indicated in my earlier discussion, I think it was two or three years ago that we reviewed this matter. There was some suggestion that there be some form of co-insurance, some modest amount of co-insurance above a certain limit. That was intended to be a way of curbing the moral hazard problem. That was not acceptable, and it's really out of this discussion that we got the notion of differential premiums, I think.

• 1705

Mr. Nick Discepola: There are two areas in the MacKay report that you don't seem to agree with. One is the recommendation that CDIC and CompCorp be merged and given the same powers. I'm wondering if you could elaborate on why they shouldn't be merged, or the benefits for Canadians on allowing them to have a separate system and separate powers.

Mr. Grant Reuber: That was what I thought I was trying to say in my paper to some degree, but let me see if I can give you a shorter version.

I think with the products you're dealing with, there is no doubt that at the edge there's some overlap on these less-than-five-year deferred annuities, but in order to fix that problem at the edge, if you put a government guarantee or if you merge them in any event, you're taking on the entire range of other insurance products. You also then have to raise the question of what about the similar savings products, deposit products, being sold by investment dealers, mutual funds, and so on.

The world isn't flat. You can always work towards making it flatter, but it's a matter of the benefits that would arise from this as compared to the cost. I'm not saying it's an undesirable objective. I'm not saying it's impossible to do. I'm saying at this stage we're a very long way, it seems to me, from being in a position, until we know what the payment system is going to do and all these other things, to then worry about how this might be modified to deal with some of these questions.

I'm not saying it's impossible. I'm not saying it shouldn't be considered. I'm simply saying that at this juncture it seems to me premature.

Mr. Nick Discepola: The other area that you seem to differ on is— I believe in September when you came and gave your technical presentation before the committee you said that the goal of deposit insurance was really to assure consumers that if they put a dollar in a bank they could feel as assured and as secure as having that same dollar either in their mattress or in their pocket. The reason for that is to prevent a run on the dollar and the banks in case of any failure or turbulence. MacKay seems to reject this, and he says that the deposit insurance is really there to protect small depositors.

So when you answered my previous question, I wondered what your view was on deposit savings. Should we, as you mentioned before, include different products such as mutual funds, such as certain deposits? Should they be covered? Should other institutions maybe be covered also?

Mr. Grant Reuber: If it's strictly a consumer protection function, then I don't see any basis on which to make a distinction between those products.

One of the great implications of this of course is that if it's government guaranteed, the government takes on a very substantial increase in its liability, because in the end if things goes wrong they get stuck with the bill. So that's a big consideration if you're going to guarantee all of this stuff.

On the main point you make regarding our role as a stabilizer, if you wish, as compared to a consumer protection sort of function, I believe one of our primary roles remains that of helping to sustain the safety net, the safety and soundness of the system. I would have some concerns about how you reconcile that if you're also primarily giving attention to consumer protection.

It seems to me there may be times when you have to do things for the safety and soundness of the system, which may not be altogether consistent from the standpoint of simply providing consumer protection. I believe that if CDIC becomes a consumer protection type of institution, its role in dealing with stability and ensuring the safety and soundness of the system will be diminished and it will not have the same capacity as it does now—

Mr. Nick Discepola: Are you saying the safety and soundness issues may not be compatible at times with consumer protection issues?

Mr. Grant Reuber: I think it changes the focus of the institution.

• 1710

Safety and soundness requires action to be taken in in some cases of closing down institutions. By putting that in the front window, as it were, it seems to me it gives a different role to CDIC than if it were simply concerned with providing resources to sustain the consumer insurance scheme.

Mr. Nick Discepola: There is a time signal by the chair, so I'll acquiesce. Thank you.

The Chairman: Sorry, I only gave you 10 minutes.

Mr. Tony Valeri (Stoney Creek, Lib.): Thank you, Mr. Chairman. I'm sure I won't need 10 minutes.

In looking at the CDIC brief, I see you start off in your brief mentioning that the devil lies in the details, as always. You go through a number of the recommendations MacKay has made on holding companies, new entrants, the mixing of commercial and financial, and organizational changes. And you've essentially laid out in your brief some of the questions that need to be answered with respect to these recommendations. But I don't, in fact, see in the paper—and I'm hoping we can have a bit of discussion around this—any potential solutions. I mean, as a committee we're here to test some of MacKay's recommendations, and of course raising the flags with respect to those recommendations is important. But I think it's also important to talk about some potential solutions.

I'm reading from your brief here and you say:

As the history of deposit insurance in Canada amply demonstrates, major changes have occurred during the past three decades in response to [market changes, reviews, and the rest].

As you look forward in the financial services sector, we're also seeing that savings vehicles themselves are changing. People are not putting as much money as they were in deposits and savings deposits. They're in money markets and T-bills. Are you carving out a role for CDIC to deal with that? You talk about CompCorp and CDIC and the amalgamation of the two, and you indicated in your earlier answer that in your mind it was premature. But what things need to be put in place before you feel comfortable about talking about an amalgamation of those two? And how do you see it? Do you see us moving to a CDIC-type system, or do you see us going to a CompCorp system? That's the kind of discussion I hope we can have.

Mr. Grant Reuber: Well, there are a number of possibilities. I think there is a sequence in which these things need to be looked at, and I would put at the top of the sequence changes, if any, in the payment system, because how that is handled, it seems to me, will have a lot to say about how a lot of other things are done.

I would then go on to say that some of this list of stuff I've indicated—and Mr. Morson also had some—such as creditor priority and the whole business of federal-provincial relations, which I think gets very quickly into the act— For example, with my friend to my right here, many members of her organization are more under provincial law than they are under federal law.

I can't give you a blueprint, but I think until those kinds of questions are addressed fairly directly there's no great advantage in changing things just because you want to shake up the system. The system is working quite well. I don't think there's any great compulsion to take dramatic action to change a system that is working well. Now, that's my perception; some people may disagree with that.

But if there are major problems that come along as we develop the payment system and so on, they can be fixed. But I'm not sure at this juncture we're even in a position to speculate on what these new product changes are likely to be. That may have a considerable influence. As I say, some of the issues that have been raised can be handled by life insurance companies, mutual fund companies, and investment dealers setting up subsidiaries that operate with the CDIC guarantee. And some of them do do that. That's not a hypothetical possibility. In fact, some do it. Some do it quite successfully; others, less successfully.

• 1715

The Chairman: Mr. Morson wanted to jump in there.

Mr. Alan Morson: If I might comment on that, in terms of how we move forward from here, I think what we've attempted to do is identify the issues and agree with a number of the issues that Mr. MacKay raised in his task force, because the nature of the task force work was such that they really couldn't have CDIC and CompCorp and others talking as part of their report.

So I looked at it more that they have identified the issues, and we're agreeing with those issues and say we think we should get on with those and have discussions with CDIC, with government officials, and with industry people, bringing into consideration some other things such as provincial versus federal jurisdiction and the nature of industry involvement, as opposed to recommending something at this point. I think it's too early, because we haven't had those detailed discussions.

Mr. Tony Valeri: So you're both in agreement with having—

Let me step back a second. Another question I would have would be, you are then suggesting that the MacKay report can be taken a piece at a time, first of all, and you both agree that with respect to the recommendation on the amalgamation of CDIC and CompCorp, you're really at the tail end of this process because you want to see these other things occur and see how they work before you start to really address some of the differences between CompCorp and CDIC.

What I don't get is, Mr. Reuber, you say the system is working well, in your mind, yet the reason MacKay suggested this was because he felt there was an advantage to CDIC over CompCorp. I guess that was based on some testimony.

Mr. Grant Reuber: Yes, from the insurance companies.

Mr. Tony Valeri: But you don't agree with that.

Mr. Alan Morson: I could comment on that, because—

Mr. Grant Reuber: I said there's no question that there is some advantage, but it's a question of how big it is and how important it is.

Mr. Tony Valeri: It's negligible, in your mind.

Mr. Grant Reuber: I don't say it's negligible, but you know the United States insurance companies operate without a federal guarantee. If they have a guarantee, it's from the state governments.

They have the full range of products we have here. The financial markets in the United States are at least as sophisticated as they are in this country, and this has not been an issue. As far as I know, I'm not aware of any move on the part of U.S. insurance companies looking for a federal government guarantee or a national system of some kind.

So I don't deny that it's an issue, and I think it's one that should be looked at, but I don't think it's an issue that is sufficiently important that it takes precedence over all these other questions that have arisen and that could arise.

I agree with Mr. Morson that there's absolutely no problem in reviewing this matter to see if a better system can be devised, and I'd be the last to disagree with that. At the moment, though, I don't think we are sufficiently informed and have thought through the process well enough to suggest that we should proceed with either of the proposals or other proposals on this matter.

Secondly, it's not at all clear that if you do in fact flatten the world out, all the benefits are going to go to the insurance companies.

Mr. Alan Morson: I would like to make two comments, Mr. Chairman.

One of the reasons there hasn't been the demand in the United States is because they have a much higher assessment capability, because in most of the states, when they pay their assessment, they can then deduct it from the premium tax that is paid to the state. In other words, in many cases, it really is the taxpayer who's paying for it, as opposed to the insurance company.

The Chairman: Mr. Reuber wasn't advocating a United States sort of style.

Mr. Grant Reuber: No.

Mr. Alan Morson: The other more direct question, though, was in connection with whether the industry sees that it is at a disadvantage. This is an industry concern, but it has done polling over the years and it has found that consumers feel there is a difference. In good times I don't think that matters very much, but in times of economic instability or uncertainly it does make a difference.

• 1720

Mr. Tony Valeri: Just in response to what you had said, you indicated that in the U.S. you're able to deduct that contribution against your premium tax that you pay. In Canada, are you not able to deduct the payments that you make to CompCorp?

Mr. Alan Morson: You're able to deduct them for tax purposes, but what I meant it would be the equivalent of in Canada— The insurance companies pay a premium tax to the provinces.

Mr. Tony Valeri: Yes.

Mr. Alan Morson: And the equivalent would be to be able to deduct their costs for insolvency from the amount they pay to the provinces, which has never been a possibility in Canada.

All I really meant was that one of the reasons there isn't the requirement in the United States is that quite a bit of the cost is actually paid for by the taxpayer.

Mr. Tony Valeri: So is that provincial?

Mr. Alan Morson: It's a state thing.

Mr. Tony Valeri: Does the province prevent you from doing that here in Canada?

Mr. Alan Morson: No, it was never set up that way. The provinces did not wish to have it deducted.

Mr. Tony Valeri: I'm just trying to understand the difference between deducted against your provincial premium tax versus deducting it against your—

Mr. Alan Morson: In the States it's a deduction from the tax; in Canada it's a deduction from taxable income.

Mr. Tony Valeri: Okay. Got you.

The Chairman: Mr. Sabourin.

Mr. Jean-Pierre Sabourin: To add to all this confusion, I should point out a few things.

I think the higher profile of CDIC is because we have indeed protected close to $25 billion, dealt with 43 failures since early 1980s, and about two million Canadians. So there's no question that CDIC has a higher profile than CompCorp.

But I think we should point out that CDIC, being a crown corporation, is statutorily required; it's obligated to repay depositors. We don't have a choice. It's not a question of whether the industry can afford it. CDIC has to repay depositors when an institution fails. That's different. I think that may be an issue of the credibility—that when we do polling people want to know more, but they know that the government stands behind the CDIC. We have thousands of phone calls on our 800 lines about whether a depositor is insured.

Mr. Tony Valeri: And I guess that may be one of the reasons why CompCorp would like to be backed by the government, so they can get out there and say the same thing. That's where the competitive advantage comes, and that was the basis of the whole recommendation.

Mr. Grant Reuber: But the proposal is not just to cover the same product. The proposal is to go well beyond the less than five-year deferred annuity to health benefits, death benefits, disability insurance, and so on. So there's a wide range for extension of the product that comes under the guarantee.

Mr. Tony Valeri: And as it sits right now, CDIC does not have a way of looking at insuring those types of products.

Mr. Grant Reuber: Well, I suppose we could insure them, but it would certainly make a larger bill if they in fact were troubled.

Mr. Jean-Pierre Sabourin: The answer is no, because it is a statutory requirement. It is by statute what we insure and what we do not insure. We only insure Canadian funds, a deposit less than five years. So if you're going to open up the system, you may have to increase the deposit level. You may have to remove the five-year limitation. There are a number of issues. And of course what is going to be the cost relates to that.

The Chairman: Well, it's great to see that government can be an advantage sometimes.

Mr. Dubé.

[Translation]

Mr. Antoine Dubé (Lévis-et-Chutes-de-la-Chaudière, BQ): Thank you Mr. Chairman. I have a question for Mr. Reuber.

On page 3 of the French version of the brief, you say that the proposed changes could affect the agreements with the provinces and that these relations could bring additional federal-provincial issues to light. Indeed, you speak of the possible complications that possible changes to what exists now might generate If I have understood correctly, you are relatively satisfied with what there is now. Could you tell me about some complications that are not set out specifically in your brief?

Mr. Jean-Pierre Sabourin: We could instead discuss what we have now by using Quebec as an example. In Quebec, there is the Quebec Deposit Insurance Board, with which we have had good relations for 32 years. The Board and the CDIC signed an agreement in 1969.

• 1725

The agreement is the following. The Canada Deposit Insurance Corporation guarantees all deposits accepted by Quebec banks and provincial institutions incorporated in the Province of Quebec, which are members of the Board, are entitled to federal deposit insurance for deposits accepted outside the province. The same applies to provincial institutions outside the Province of Quebec that accept deposits.

The agreement works well. Relations are good. The CDIC can also grant loans to the Quebec Board. We therefore have a federal- provincial agreement that functions well. In cases of bankruptcy, the Quebec Board and the CDIC have worked together to ensure that depositors are repaid up to a maximum of $60,000. For example, a depositor with a $60,000 deposit in Hull and a $60,000 deposit in Ottawa with the same institution is insured for only $60,000: $30,000 would be covered by the Quebec Board and $30,000 by the Canada Deposit Insurance Corporation.

That is the agreement we have. It has been working well for 32 years and people are satisfied with it. If federal deposit insurance is taken away, what will happen to our relations?

Mr. Antoine Dubé: I understand. Now, for the Canadian Life and Health Insurance Compensation Corporation, you are saying, perhaps along the same lines, that some thinking is required about the desirability of federal and provincial government participation. You went no further than that. What is there for the provinces to consider with the federal government?

[English]

Mr. Alan Morson: If you'll excuse me speaking in English, what we meant by that is that CompCorp, as it now exists, is a national organization, and the Quebec companies are members of CompCorp and are part of our assessment base. If there is a change, if there is a merger, one of the things that will have to be addressed is how that is handled. Will we have the same sort of agreement Mr. Sabourin has talked about that was forged a number of years ago, or how will that be handled?

What I was really saying was that this is one of the things that needs to be taken into consideration, because if you're merging a federal and a national organization you have to worry about the different representation.

[Translation]

Mr. Antoine Dubé: From your standpoint, Ms. Reszel, as one of the presenters told me, your objectives come under provincial jurisdiction. Are you afraid that the change would lead to the same effects? Do you fear the same problems if things were changed in terms of the provincial agreements that affect you?

[English]

Ms. Rozanne Reszel: As it relates to the insurance and deposit-taking industry, or as it relates to the securities industry?

[Translation]

Mr. Antoine Dubé: Either.

[English]

Ms. Rozanne Reszel: I think there are a variety of places where our industries come together and have to make mutual assessments of each other's systems. I was just reflecting back to some discussion on opening up the payment system. Certainly there are other models where our industries come together, where the investment dealers industry and the banking and trust industry come together in clearing corporations like the Canadian depository system, which clears securities and debt. That seems to work effectively, with the regulation of different participants occurring at the provincial and federal levels and the involvement of the Bank of Canada.

Certainly internationally the three pillars are coming together and having discussions in the joint forum, as was discussed in the background papers, looking to find some common ground where we are doing the same kind of business to provide the same sorts of protections. Some of those conversations have also been had here in Canada, where securities industry regulators have sat down with regulators from OSFI to try to make comparisons of areas where we have similar kinds of business.

• 1730

I think there is a very effective collaboration and exchange of information that goes on back and forth. That doesn't take away from the complexity of the world we live in, though, where you can be doing the same kind of business and be regulated provincially to a particular set of rules because of the industry label you are in or federally to a different particular set of rules because of the label you are in. I think there's still a lot of ground to be covered in terms of reviewing those areas where we need to find some convergence in the regulatory framework.

[Translation]

Mr. Antoine Dubé: Thank you all for having submitted documents in French. I have not had time to read them all, but rest assured that I will. Thank you for your participation.

[English]

The Chairman: Thank you very much, Mr. Dubé.

Mr. Pillitteri, final question.

Mr. Gary Pillitteri (Niagara Falls, Lib.): Thank you, Mr. Chairman.

I'm sorry for missing the presentations, but one thing I wanted to know— I was on the Liberal task force, and some questions came out on the banks and the mergers. What I want to know is that at one time it was said the Canada Deposit Insurance Corporation were in a deficit. I understand they are no longer in a deficit. I also understand there was some disagreement within the ones making the payments, the banks, on what amounts and what should be a level for protection. Are they solvent now? Are they no longer in the red? Is it in the black now? That's one part of the question.

Shouldn't the insurance be made public to the people? Even being a parliamentarian, I don't know how much protection there is there for a consumer. Shouldn't that be a disclosure to consumers, seeing how solvent they are, and what there is there to protect the depositors? I know the government ultimately is behind it, and everyone is protected, but are the banks and those deposit takers paying the full premium? Are they solvent, or are they behind? Shouldn't that be disclosed to the public so they become more knowledgeable of what's happening?

Mr. Grant Reuber: I'm not altogether sure of your question, but let me try, and then you'll elaborate if I'm off the track.

It is true CDIC has paid off all its debts and its deficit will disappear this year. I think we've made no secret of that. We're rather pleased in fact that this has happened, so that's not a problem in terms of informing the public.

As far as the institutions themselves are concerned, I can tell you that we have at the moment very few institutions on our watch list, a very small number, and that's been a considerable reduction from five or ten years ago. They are required to disclose their financial information under the various acts of the government, federal or provincial, as the case may be.

I don't really know what in addition you would like to have disclosed. You may ask that they disclose more or more fully, in which case I have great sympathy with that. But I think one of the problems with increased disclosure is that for the customer who is insured, the incentive to pay attention to additional information on disclosure is very small.

Mr. Jean-Pierre Sabourin: I have a few comments.

I think it's important to note that CDIC takes its responsibility to inform the public very seriously. If we have a deposit insurance system, it should be understood. Since 1983 CDIC has issued over 30 million information brochures to the depositing public.

We also have toll-free information lines where any depositor across Canada can phone us and ask questions about deposit insurance. Since inception in 1989 we've taken over 500,000 calls from the depositing public. Questions we receive are who's a member; what kind of insurance; is my joint account insured; what happens to my money in case of failure; is this new institution a member; am I protected?

• 1735

Last year, we put in place a very elaborate consumer information bylaw to ensure that the depositing public is aware of the insurance coverage at the point of sale. So a depositor today can walk into a branch and say they would like to have a list of all of the deposits insured by CDIC. They will be given a copy. All of them have been reviewed by CDIC and approved. If they're on that list, they're insurable and eligible for deposit insurance.

We also have web sites. We're hot-linking web sites to our member institutions to provide information to the public. So from the perspective of information, we're moving ahead. We've also done TV ads, etc.

The last point I'd like to mention on that aspect is that our three agencies have been working together in trying to find a solution to all of the complexities of our plans and developing some form of information brochure or process so that we can inform the public about all of our plans. This is so that a depositor doesn't have to look at all kinds of places to try to figure out what's insured under the insurance program and what isn't under CDIC or CIPF, etc.

So we've been meeting as a group. We're working toward trying to find the solution to increasing consumer awareness and knowledge about the protection programs that are available.

Mr. Gary Pillitteri: Just to follow up, Mr. Chairman, this was only a preface. I want to continue on one more little area if possible.

A lot of times I get asked the following question. If I have one deposit in this bank at $60,000 and then I have another deposit in another bank for another $60,000, am I guaranteed with both of them, and how much am I guaranteed?

I want you to answer that, but there's another part to that question. I do understand and know from when we had some hearings that they became more vulnerable south of the border. They were in the red. Certainly they have come on to make sure there's over $30 billion in insurance there just in case of any failures. What is there as a counterpart in Canada? I know that goodwill and everything is behind it, but is there any actual amount that you could say to me is there?

Mr. Jean-Pierre Sabourin: I think in the U.S. you have to look at the FDIC. It's a large organization that insures hundreds of thousands of banks. As for Canada, we have 113, while they might have 10,000 to 12,000 banks in the U.S. So it's a different system. They do have failures, and they acknowledge that. In some cases, they'll have 200 failures in one year. But those failures are not the size of our large institutions, because they're smaller institutions.

They decided under the Federal Deposit Insurance Corporation that they would have a fund of about $30 billion. As a matter of fact, they decided not to charge premiums because the fund is more than adequate with the income stream it throws out as interest.

As the chairman pointed out a moment ago, our decision has been to set up a provision for loan loss based on a model. In other words, this means past failure losses, the credit ratings of institutions, and the spread between the subordinated debt and Canada bonds. That's a model we put in place about two years ago, and we will enhance it over time.

Our decision has been not to set up a large fund because our position is that the first line of defence to solvency is profitability in institutions. This corporation does not need a large fund that would invest for whatever reasons in case of a rainy day. Our system is set up so that we can charge our member institutions post-assessment.

The $5 billion in losses that CDIC has suffered, including $1.7 billion in interest that we paid to the government, has been completely repaid by the industry over time. So it's not a question of whether the taxpayer is going to be picking up the cost of these. The institutions are funding it. We borrow from the CRF, as we have done in the past. Now with the legislation in 1992, we can go to the market. It will be a matter of borrowing first, dealing with the problem, and then having the industry pay that back over time. So it's a funding mechanism.

The Chairman: Thank you.

• 1740

Mr. Sabourin, I want to follow up on a question by Mr. Pillitteri. You stated that now you actually list the products, all the things you cover, right? You've been around since 1967.

Mr. Jean-Pierre Sabourin: Yes.

The Chairman: When did you start doing this?

Mr. Jean-Pierre Sabourin: Last year.

The Chairman: Why did it take so long? Is that a fair question?

Mr. Jean-Pierre Sabourin: The system has evolved. I've been around the CDIC for 22 years, so I've lived a bit of this. I think it has evolved, because we've seen the concerns in the late 1980s. I was involved in Principal Savings and Trust, the CCB, and Northland Bank—all the failures out west. I lived out west and dealt with the failures in 1983, 1985, and so on.

The biggest concern we had was that the public was not getting the correct information. There was bait and switch. You'd walk into an institution and they'd say, buy deposit and we'll sell you something else; it can give you a higher return. So in 1989 we decided that what we would do is basically have a simple source of information. If you need information, contact CDIC. So we set up 1-800 information lines; we issued information brochures to every household; we insisted that institutions have membership signs and brochures in the branches.

Over time we've worked with the industry to try to develop a system that makes sense, works, and is administratively sound, not an administrative nightmare. It took us almost three years to develop this program, because we had to review not only every deposit instrument, but also the documentation behind that, which is basically almost a legal opinion for each product, and put a system in place where not only have we pre-cleared all these products, but we also have a compliance regime where institutions have to file with us annually their register, their list, and we verify it with our data bank. Furthermore, any institution that is a member of CDIC, prior to issuing a new insured product, has to send it to CDIC for confirmation and review, because we want to make sure these lists are always up to date.

So that was a very long process. We wanted to make sure we had it right, and we did do a lot of polling to find out what kind of information was available. This system works, and it's working very well. The feedback we're getting is that depositors can ask questions, and what we need to do is keep pushing on it.

You're right, Mr. Chairman, it takes a long time. There's no question about that.

The Chairman: You were formed when I was seven years old.

Mr. Jean-Pierre Sabourin: I could point out that the first failure in 1970 was small. CDIC had very few failures until 1983. It started in 1982-83, and from 1983 to about 1987-88, CDIC was closing down financial institutions and repaying depositors. Then we had the same problem from 1992 to 1993-94, closing down 43 institutions.

Unfortunately, we were more crisis-oriented and focused on repaying depositors than looking at what we were going to do next. So when the smoke cleared in 1993, we decided to put in all of these consumer information bylaws, differential premiums, and standard, sound business and financial practices. Our policies and processes are up to date, and we have put a lot of systems and processes into our organization to deal with the future.

The Chairman: Also, would the industry themselves have been able to publish their own list?

Mr. Grant Reuber: No.

The Chairman: Why is that?

Mr. Jean-Pierre Sabourin: The deposit insurance system is complicated—terms and conditions, repayable within five years— I'll give you an example: indexed linked products today. The question is, some of them issue indexed linked products where the principal is guaranteed. Some of them have minimum interest covered; some of them don't. In some of them the interest is based on the performance of the TSE over five years at a certain point in time—averaging. They become complicated.

The Chairman: It has to be centralized.

Mr. Jean-Pierre Sabourin: It has to be centralized, and CDIC basically had to take every instrument and ask, does it fit the definition of deposit; is it an insurable product; is the interest insurable? We had to go through every document, and it took us almost three years. There are about 2,900 products.

The Chairman: Is this a very expensive proposition?

Mr. Grant Reuber: Once it's up and running, it's okay. It has to updated and maintained, but the big cost is the front-end cost of getting it put in place.

You should understand that until this system was put in, it was illegal for a sales clerk to tell you whether a product was insured or not in an institution. That came out of the Principal fiasco in the 1980s. It was not a very satisfactory system, as Jean-Pierre points out. And while I wouldn't want to say this is completely trouble free, at least it seems to me that it's very clearly on the right track. Not only do the customers now know, but the people selling the product now know whether it's insured or not in many cases. That wasn't clear before either.

• 1745

Mr. Jean-Pierre Sabourin: The last point was that in the legislation we also have a lot of compliance and sanctions requirements. There are substantial sanctions against the employees in member institutions and in the institution itself if that consumer information bylaw is not followed.

The Chairman: I'm very glad to see some progress is being made in this area, because one of the things I can tell you we've heard quite consistently in all the hearings we've held throughout the country is that consumers expect a lot more from the financial services sector. Unlike the past, when they were just sort of expecting a lot more, they're now demanding a lot more. It's great to see that organizations like yours have responded in this fashion.

I know we're running a little bit behind schedule. That usually happens when the panel is interesting. On behalf of the committee, we want to thank you very much for helping us as we try to address key issues of concern for Canadians as they relate to the MacKay report.

The meeting is suspended for 45 minutes. Thank you.

• 1746

• 1834

The Chairman: I'd like to call the meeting back to order and welcome everyone here this evening. We're pleased to have with us the Superintendent of Financial Institutions, Mr. John Palmer, along with Nicholas Le Pan.

Welcome, Mr. Palmer. You know how this committee operates, of course, since you've been here many times. You have ten to fifteen minutes to make a presentation, and thereafter we'll engage in a question and answer session.

Mr. John R.V. Palmer (Superintendent, Office of the Superintendent of Financial Institutions): Thank you, Chairman. I'd like to thank the committee for inviting us here today and for giving us an opportunity to talk about the task force report.

As you know, I'm John Palmer, the Superintendent of Financial Institutions. With me is Nick Le Pan. Some of you know him; he is the deputy superintendent of supervision in my office.

Before beginning, Chairman, I'd like to point out that we had prepared a longer opening statement than the one I'm going to read this evening, but we've been encouraged by the clerk to be briefer. As a result, we'd like to table that longer statement and have it appended to the record of these proceedings.

• 1835

The Chairman: Very good, and we'll read this into the record. Thank you.

Mr. John Palmer: Fair enough.

[Translation]

Before beginning my statement proper, I would like to congratulate Mr. MacKay, as well as the members of his group and his staff, for having successfully completed this very complex project. I know just how much work was required to deal with our presentations to the Task Force, and can appreciate its efforts to cover a host of general and complex questions in a very short time.

[English]

The underpinning to my comments today is the principle of balance between sometimes conflicting policy objectives. The task force is seeking to achieve some important policy objectives, including increased competition and enhanced consumer protection. However, recommendations to achieve these objectives could have an adverse effect on the government's ability to achieve other objectives, including depositor and policyholder protection and a high level of public confidence in the financial system.

We recognize that important benefits may result from many of the task force's recommendations. We also perceive that some of the recommendations may give rise to offsetting costs or risks. In our view, the possible costs and risks of the task force recommendations that must be considered along with the potential benefits include: increased risk of failure in institutions, and losses to depositors and policyholders as a result of a number of proposed initiatives intended to increase competition and open up a sector; conflicts arising from expanding OSFI's statutory mandate with respect to competition, innovation and consumer protection; and an apparent conflict between increased transparency in some areas and reduced transparency and greater discretion in others. Let me elaborate on some of these issues.

Many of the report's recommendations have as their direct goal or indirect consequence the opening up of the Canadian financial sector to more participants. As examples, I refer to the proposals with respect to ownership policy, the possible lowering of initial capital requirements for new participants, and branching by foreign banks.

While the goal of these recommendations is to increase competition and efficiency, resulting in more choice and lower costs for users of financial services, the consequences of opening the market to new entrants may be the establishment of institutions that pose increased risk and, ultimately, additional cost to the system. This is not to say that the goal of increasing competition and efficiency is not a legitimate one or that it is not viable, nor should this goal necessarily be rejected only because it would increase the risk of institutional failure. As the risk increases, however, it is necessary to consider the consequences and ask ourselves whether we're prepared to pay that price.

It may be necessary, for example, to ensure that existing public expectations with respect to the degree of protection in the system are lowered—at the moment they're very high. More emphasis may have to be placed on the issue of disclosure. The adequacy of existing regulatory tools may have to be reconsidered. It may even become necessary to reconsider the role of regulation and supervision.

[Translation]

From our point of view, it is important for Canadians, in the discussions surrounding the implementation of measures designed to improve competition and efficiency, to be fully informed about the risks and the price to be paid.

[English]

With respect to OSFI's role in the area of competition, regulation and supervision necessarily involve some degree of intrusiveness into the affairs of institutions. This may have direct and indirect costs, and therefore some impact on competitiveness. As part of its statutory mandate, OSFI is required now to fulfil its role with due regard to effect on competition. This is a passive requirement, but it's a useful one in our view because it helps us resist the temptation of excessive regulation. As we interpret this requirement, OSFI's duty is to interfere as little as possible with competition, but we do not see this giving us the responsibility to actively facilitate competition. Instead, OSFI's overriding objectives currently are to safeguard depositors and policyholders from undue loss and to contribute to confidence in the financial system.

• 1840

Recommendation 112(b) suggests that OSFI's mandate be revised to make it clear that OSFI has the responsibility to balance considerations of competition and innovation with its current statutory obligations with respect to safety and soundness. The task force also states that it does not believe OSFI's role with respect to competition should be elevated to the point where it is required to promote or foster competition.

We're not opposed to competition and innovation, both of which are indispensable to the proper functioning of the financial sector, as well as its vitality and growth. However, they're not matters within OSFI's control and may sometimes conflict with matters of safety and soundness. For example, our current mandate emphasizes the importance of early intervention into the affairs of troubled institutions. The desirability of early intervention was one of the lessons learned from the financial problems of the 1980s. It has been considered and promoted by the government and by the House finance committee itself, and was codified in our 1996 mandate. The addition of a specific responsibility for competition and innovation might put increased pressure on OSFI to exercise regulatory forbearance—to back off, if you like—to the detriment of early intervention and early resolution of problems.

In addition, combining matters of competition and innovation with OSFI's current mandate could make OSFI less independent and more vulnerable to pressure based on non-regulatory concerns. In approving new entrants to the financial system, regulators traditionally apply a fit and proper test to the people behind any application. If competition were a more important part of OSFI's mandate, OSFI might be placed under pressure to accept less-than-desirable owners of financial institutions. We would therefore ask you to consider whether issues of competition and innovation belong more appropriately to the market and to other government players.

[Translation]

Even though we may have doubts about including responsibility for competition in our mandate, we believe that it is possible to develop a more flexible regulatory approach to foster competition. We feel that such an approach would have to include the principle of early and forceful intervention, but could also be tied to fewer regulatory and monitoring procedures, particularly for institutions in sound financial health.

[English]

Recommendation 112(a) proposes that OSFI's mandate also be broadened to include more responsibility for consumer protection issues. We understand the need for additional consumer protection initiatives, and we fully support them. We're inclined to add that our existing safety and soundness focus may be one of the most important aspects of consumer protection within the financial services industry. We like to think we protect consumers now by helping to preserve and enhance the ability of institutions to meet their financial obligations to those consumers, but the reservations that I have expressed with respect to increased responsibility for matters of competition apply equally to the proposals for increased responsibility in the area of consumer protection.

First, an expanded consumer protection role may conflict with OSFI's responsibility to promote safety and soundness. For instance, the recent vanishing premium issue pitted policyholders against insurance companies over the issue of duration of premium payment based on estimated rates of inflation and investment return. Certainly, OSFI has a responsibility to protect policyholders' interests, but how should OSFI best do so? Is it by maintaining an adequate level of safety and soundness in the institutions, or by trying to advance particular consumer interests? It's unclear which role would take precedence in the event of a conflict. Further, OSFI does not currently have the resources, skills, or even the management mindset required to fulfil an expanded consumer protection function. We would have to hire new people with the relevant experience. In short, although we support consumer protection initiatives, we would ask you to consider whether OSFI is the body best suited to take on a consumer protection mandate.

• 1845

I'll now turn from these general issues to a brief discussion of some specific areas of the report relevant to OSFI's current responsibilities.

Recommendations 29 to 41 propose a number of changes to the rules concerning ownership of financial institutions. If these recommendations were to be accepted, they would alter the current rules in important ways. Some schedule I banks and mutual insurance companies that chose to be mutualized would no longer be required to be widely held.

Ownership requirements would be based on the size of the institution. When combined with recommendations 4(a), 4(c), and 9, which would permit respectively the incorporation of institutions with less capital, differing degrees of regulation based on size, and the facilitation of activities by foreign institutions, the potential exists for more closely held, commercially linked institutions.

It's our view, and it's a view shared by most regulators, that closely held ownership of financial institutions provides greater scope for risk than widely held ownership, and that commercial links further exacerbate the risk. The history of financial institution failures in Canada tends to support this view.

Recommendations 25 to 28 propose institutions be permitted corporate structures best suited to their operations. They also set out principles for the regulation of holding companies and recommend the current restrictions on downstream investments be reviewed.

Recommendation 26 also recommends the development of a new financial holding companies act. It has always been and continues to be our view that financial holding companies raise a number of issues and present a number of risks that do not arise under a widely held ownership regime applicable directly to the regulated financial institution.

They would also significantly add to and complicate OSFI's regulatory and supervisory challenges. While the principles enunciated by the task force in connection with the regulation of holding companies would lessen some of these risks, the risks and complications can not be eliminated altogether. As noted by the task force, its recommendations with respect to holding companies are based on suggestions received from OSFI.

These suggestions were made with the reservations I just expressed, and represented what we saw as minimum standards for providing a reasonable degree of protection to depositors and policy holders of regulated financial institutions within a holding company regime.

Further, our development of these principles was based on the assumption holding company structures would be available only to widely held institutions. As the task force has recommended the regulated holding company regime be extended to closely held institutions, these principles may have to be reviewed.

We support the proposal to review the current restrictions on downstream investments in conjunction with the holding company regime. In fact, we believe this review should occur irrespective of whether the government proceeds to implement a holding company regime.

Recommendation 113 proposes that OSFI should have a board of directors with specific responsibilities. In principle, we support this recommendation. While a number of technical details will have to be addressed, we are of the view the creation of a board of directors would provide oversight on important administrative and management matters, thereby increasing accountability and insuring effective use of financial and other resources, and would contribute expertise and experience to OSFI's processes.

In defining the board's responsibilities, care would have to be taken to ensure the powers of the superintendent and the minister were not undermined, and the existing accountabilities in the system, from superintendent to minister and from the minister to Parliament, were not altered.

Recommendation 42 proposes OSFI work with the Canadian Institute of Chartered Accountants to eliminate competitive disadvantages caused by inconsistent treatment of goodwill in business combinations. We support this recommendation and are pleased to advise action has already been taken along the lines recommended.

During the question period following this presentation we'd be pleased to provide further details. I know you are meeting with the CICA fairly shortly, and they will be prepared to tell you more as well.

We have some technical questions with respect to certain recommendations and the manner in which they are to be implemented, but this is not the proper forum for resolving technical matters.

• 1850

[Translation]

That said, I would nevertheless like to make a more general observation. Many of the recommendations would lead to new types of financial institutions or to changes in their structure; however, the report says very little about new regulatory jurisdictions. Some of the new institutions might experience problems or even go bankrupt, and the rules governing their withdrawal from the system might be as important as those encouraging them to enter it.

[English]

In summary, Mr. Chairman, we support the objectives of the task force: to encourage greater competition and innovation within the Canadian financial system, and to enhance the protection available to consumers. In doing so, however, we think it important to understand the implications of any changes made to achieve these objectives. This is with respect to the safety of the system, the ability to protect the savings of depositors and policyholders, and the careful weighing of the benefits and costs of any change.

At the end of this process, we think that the challenge presented to you and the government is to achieve the optimum balance between the benefits and costs. It won't be easy to find the right balance, but it's essential for Canadians that you do.

Good luck in your important work. Thank you, and we look forward to your questions.

The Chairman: Thank you very much, Mr. Palmer.

We'll have a five-minute round. Mr. Harris.

Mr. Dick Harris: Thank you, Mr. Palmer.

It's really coincidental that you're here tonight, because the night before we had a lady by the name of Ms. Anne Holmes. She represented life insurance policyholders, and I'm sure you're well aware of her name.

Mr. Palmer, certainly in the position you are in on the government side you are the most powerful person in the financial institutions business in this country. You are overseeing the activities and the regulations. I would imagine that you could appropriately say that the buck stops at your desk.

Now, given your position and the power of your office, Ms. Holmes told our committee the other night that she has approached your office. She asked for help based on her alleged experiences with several life insurance companies and those members of her group. But she has received basically no help from your office in trying to resolve the allegations she's had.

I find this rather confusing, considering that you're the person who oversees all the activities of life insurance companies. One would have to assume that as part of your job you would want to ensure that everyone who was operating in that business would be free from any allegations of malpractice, deceptive practices, whatever. So I'm surprised that Ms. Holmes would come to us and say that she has had no help from your office.

Would you like to respond to that?

Mr. John Palmer: Thank you, Mr. Harris.

I think Ms. Holmes has approached a number of government agencies. She has asked us to intervene regarding some specific issues involving sales practices and representations of companies concerning particular policies. We have declined to get involved in those specific, individual consumer issues.

There are several reasons for this. First, we believe that the particular responsibility she would like us to undertake is a provincial responsibility; it does not fall within our existing mandate. So we believe that we have no legal basis for intervening on behalf of specific consumer groups.

Mr. Dick Harris: Well, if I could just interrupt, Mr. Palmer, I appreciate what you're saying.

You made a statement earlier. You indicated that you're unclear what role you should play with regard to consumer groups. But here we have an industry that is operating within a regime that is directly under your control. You are the top guy in Canada in the overseeing of this industry.

• 1855

I assume that you would want that industry to run just as seamlessly and problem-free as possible. When you say it's primarily a provincial matter, it sounds to me like you are actually passing the buck. I can't understand that from a man in your position. I would assume that the buck would have to stop with you.

Mr. John Palmer: Mr. Harris, I think you have a misunderstanding of the reach of our powers and responsibilities. We don't have the responsibility for managing financial institutions. We do not have responsibility for overseeing every aspect of every function carried out by financial institutions. Our mandate makes it very clear that boards of directors and the managements of institutions themselves have the primary responsibility for managing institutions.

If we were to undertake something with the sort of scope you are suggesting, we would be a far larger body, a far more expensive and intrusive body than we are at the present time. I'm not sure the system would want to bear the costs and the impact on competitiveness that this kind of very intrusive regulatory regime would entail.

Furthermore, it would duplicate existing activities already carried out by provincial governments. They do have the responsibility for regulating sales practices and the representations made by companies to their customers concerning the benefits of policies.

Let me just continue. This is not to say that we are not interested in the sort of issues raised by people who are having concerns about representations made by companies with respect to their policies. But our concern tends to be based on our mandate regarding fundamental safety, soundness and solvency.

When allegations of this kind are made, we want to understand the effect on the institution's financial strength, its ability to meet its financial obligations to all its policyholders. So we don't get in and champion the cause of any particular policyholder group that may be alleging that they should be receiving greater financial benefits as a result of sales representations. But we do try to understand the liability the company may face.

In a broad sense, if the company is facing a substantial liability, and it's clear that they have made mistakes, we do work with the company to ensure that internal controls are in place to prevent that kind of financial exposure from emerging.

Mr. Dick Harris: Mr. Palmer, Sun Life was just exposed to a class-action suit. That required a massive pay-out to many of their policyholders. In fact that exposed them to a severe loss.

I would think that your office would be concerned that other life insurance companies would be operating completely within the regulations and proper business practices so they would not be exposed to the same types of lawsuits.

I think that could be filed quite appropriately into the file of your office. It would ensure that insurance companies could continue to pay claims. If an insurance company was hit with a massive lawsuit that could severely impede their ability to pay their policyholders' claims, then that falls right into your backyard.

Mr. John Palmer: This is a very good example of the fact that expanding our role in the area of consumer protection is a genuine issue. If we were to take on the responsibility you're arguing we should—and I understand the point you're making—we would really find ourselves on both sides of the issue. On the one hand, we might be supporting, helping a particular consumer group that felt they were owed more money from the company.

• 1900

On the other hand, we have an obligation to make sure companies don't pay out too much and don't take unexpected hits to their balance sheet. This could compromise their ability to make the pay-outs to their policyholders in general.

At present under our solvency mandate we come down on the second half of that responsibility. We're not disinterested in the issue, but our focus tends to be on internal controls. We focus on ensuring that they have compliance departments.

For example, we've been pushing the institutions, the life insurance companies, to appoint a single compliance officer within their organizations. That would ensure that senior managements and boards would have greater assurance that the companies are in compliance with both federal and provincial laws. Of course, they're subject to laws in all these jurisdictions. But we have not reached the point where we see any basis for intervening on behalf of individual policyholders on issues of this kind.

Mr. Dick Harris: Unfortunately, individual policyholders do not have the resources to fight these mega insurance companies in court. So they're basically thrown to the lions unless somebody is going to be looking after their interest.

As I understand it, your office is funded by the taxpayers of Canada—I think that it would be, unless I'm mistaken about that—and contributions from the industry. So I think that one of the things this committee might consider is some expansion of the roles of your office.

The Chairman: Thank you, Mr. Harris.

[Translation]

Mr. Desrochers.

Mr. Odina Desrochers (Lotbinière, BQ): Messrs Le Pan and Palmer, thank you for your presentation. As you know, we are entering a phase in which the financial world is having to undergo many changes, and we are now studying the prominent issue of bank mergers. Consumers and bank customers would like some form of oversight committee to be established to make sure that banks meet their commitments. Do you believe that this monitoring role could come under the Office of the Superintendent of Financial Institutions?

Mr. John Palmer: Mr. Desrochers, I want to make sure that I have understood your question properly. Are you speaking of commitments that would come about after bank mergers are approved?

Mr. Odina Desrochers: I was speaking hypothetically, Mr. Palmer. I will speak slowly so that you can understand. Let us assume that the merger of four banks is approved and that consumers want to make sure that the banks will meet their commitments. Consumers have suggested to us that a kind of oversight committee or agency be established to act as a watchdog and perhaps even intervene if commitments are not met. Do you believe that the Office of the Superintendent of Financial Institutions could assume this responsibility?

Mr. John Palmer: Mr. Desrochers, in my view, we have the power now to ensure that institutions meet their commitments in terms of the "prudential area". On the other hand, it is not our responsibility to monitor their compliance with commitments in other areas, such as jobs. It might perhaps be necessary to increase government powers to ensure that institutions meet their commitments at this level.

Mr. Odina Desrochers: Mr. Palmer, are you then maintaining that if your mandate was broadened, you would be able to oversee all aspects related to a possible merger?

Mr. John Palmer: Mr. Desrochers, everything would depend on which aspects you are referring to. We have the resources and expertise needed to oversee some important aspects of these merger plans, but not all. Our supervisory work does not consist of examining and reviewing every transaction, nor every detail of bank activities or the activities of other financial institutions.

• 1905

Mr. Odina Desrochers: Mr. Palmer, I am not asking you to take on work like that of the Auditor General. I understand your point of view. But if your office cannot oversee all of the major commitments that banks make, such as consumer protection and guaranteeing jobs, who can? People need to feel secure and to know that an oversight body or an office like yours is there to do the job.

Mr. John Palmer: In my view, Mr. Chairman, what needs to be determined is who is responsible for consumer protection. Mr. MacKay made a number of recommendations about how to improve such protection. He recommended that our office, the OSFI, agree to assume some of these responsibilities. It is a point of view that I understand, although I am somewhat reluctant. It would be possible to create another government body to assume such responsibilities.

Mr. Odina Desrochers: Is this a role that is of interest to you?

Mr. John Palmer: Personally, I am afraid of such a mandate, because I already have major challenges to meet. It is very difficult to supervise financial institutions and the application of existing regulations. This additional mandate would be an enormous responsibility. I want to do good work and discharge all the responsibilities entrusted to me properly.

Mr. Odina Desrochers: Thank you very much. Thank you Mr. Chairman.

The Chairman: Thank you Mr. Desrochers.

[English]

Mr. Brison.

Mr. Scott Brison (Kings—Hants, PC): Thank you, Mr. Chairman. Thank you, Mr. Palmer.

Mr. Palmer, could you explain to this committee the function of the case review committee that reviews, or is said to review, actuarial estimate requests for Canada Pension Plan information?

Mr. John Palmer: Mr. Chairman, I'd ask for your guidance as to whether that question is in order. This is a question about the Canada Pension Plan. I'm happy to answer that question if you consider it to be in order.

The Chairman: It's not dealing with the subject at hand. We're dealing with the MacKay report.

Mr. Scott Brison: It's a relevant subject. It's a subject that I think has ramifications relative to credibility and with all kinds of regulatory areas. In fact it's an area we discussed.

The Chairman: Yes, but am I to assume that you're running out of questions on the MacKay report, Mr. Brison?

Mr. Scott Brison: There are always good questions. They're running out of answers on a wide range of issues, but it's not a question of running out of questions. There will always be good questions.

Mr. Paul Szabo: The committee's waiting now. We're coming to that in a few minutes.

The Chairman: I think we perhaps should focus on the issue at hand and respect the orders of the day, which are that we're basically studying the MacKay report.

Mr. Scott Brison: I'll express my disagreement, Mr. Chair, but I respect your role as chair and will continue. Thank you, Mr. Chair.

Mr. Palmer, are you familiar with the proposal called the Postmodern Bank Safety Net, which was published by the American Enterprise Institute, on a more self-regulatory approach to financial or bank regulation? The idea is to take in subordinated debt, which is effectively to use subordinated debt as a means for individual financial institutions to monitor. What do you think of this idea?

• 1910

Mr. John Palmer: I think it's an interesting and promising idea that deserves I think more attention and more study. Just by way of background for members of the committee, this is a recommendation to increase the impact of market discipline on financial institutions based on the logic that in the long run modern financial institutions are so complex that regulators are never going to be able to catch up, are never going to be able to provide the sort of oversight and the sort of protection that savers really require, and therefore the objective should be to expand the number of institutions that are really subject to this market discipline.

Right now publicly traded companies are subject to a degree of market discipline because they have publicly traded vehicles. So this proposition would go to the smaller institutions and say they're required to have publicly traded securities too so the analysts and the markets will follow them.

Although I wouldn't be ready to accept that recommendation in toto yet without further study and without seeing it operate perhaps in a few examples, I think the overall principle is an important one. It's worth noting, for example, that New Zealand has gone to an almost complete market discipline model and has abandoned many of the traditional regulatory functions. I note parenthetically that they don't have a domestic banking industry, but there is merit to this line of thinking.

Mr. Scott Brison: The Chicago Federal Reserve in the 1980s did a study on this as well, a working plan.

Mr. Nicholas Le Pan (Deputy Superintendent (Supervision), Office of the Superintendent of Financial Institutions Canada): There's been quite a lot of looking at this idea.

One of the issues that I think is very important is that in Canada, for example, at the moment there is not a very active market for this kind of debt for smaller institutions. The costs of this are not immaterial. So I think there is an issue, and it was looked at very seriously in Canada as part of the review of the system about five or seven years ago.

One of the views was that to absolutely force this on all smaller institutions would be potentially quite deleterious to them, and that the market discipline benefits and market disclosure benefits would be outweighed in part by the costs and so forth, and actually that might contract the number of smaller and medium-sized institutions that would be able to participate. So I think it's another example of balancing, about how to balance the need to have these kinds of institutions in the system with a transparent regulatory regime.

There are also other ways to enhance disclosure to allow markets to better judge the health of these institutions. Perhaps it ought to be part of the mix.

Mr. Scott Brison: One of the arguments against that we have heard, and it was made actually earlier today by Mr. Godsoe of the Bank of Nova Scotia in talking about the mergers side of this issue, is that the merged banks would be too big to fail.

The “too big to fail” argument has some supporters. However, a lot of Canadians look at our current banks and think they are too big to fail already, and that the logical corollary of Mr. Godsoe's arguments would be that in fact we shouldn't force banks to actually become smaller if in fact we are ingenuous about banks being too big to fail.

I'd appreciate your feedback on that as well as your feedback on globalization and its impact particularly with the complex financial instruments like derivatives. How can we track our financial institutions' participation in those types of complex financial instruments, particularly when you look at organizations like CIBC, which is involved heavily in them? How are we going to do it without some type of global cooperation? Please address those two questions.

• 1915

Mr. Nicholas Le Pan: The first question is on “too big to fail”. The first point I'd like to make is that I'm not aware of any explicit policy that any institution is too big to fail. If we were to have an explicit government guarantee for institutions above a certain size, I think that would have some quite different implications for our system from what we have today. Therefore, we operate under the presumption that we have to be prepared, together with the other participants in the system, the Bank of Canada, CDIC and others, to resolve without government support any kind of potential problem that may arise.

This is not to say that resolving a problem in a big institution would be simple. It would be messy. There is no question about that. It is the experience from other jurisdictions. But we operate under that presumption. I think it would be wrong for people to assume that there is an explicit guarantee on behalf of governments at this point.

You then relate that to the issue of mergers and so forth, and what would mergers do and so on. I think that is an important question. I think there are one or two points I'd make about that. One is that I think the experience in looking at the “too big to fail” issue in other countries and in this country is that there are no easy, simple answers as to at what point does this kick in, at what point are institutions a problem from a safety net point of view, from a “too big to fail” point of view and so forth. I think it is unlikely that analysis of this issue will produce a simple, clear-cut answer on whether mergers should or should not happen.

Even if there were “too big to fail” issues, there may well also be mitigants. Part of the literature and the discussion in other countries around the size issue and the implications for system stability are very much issues around are there other mitigants if this is a concern. There may well be, and then it becomes again a balancing question.

I'll note, by the way, that in the MacKay report itself, when it considered the framework for looking at mergers, it did not make a pronouncement on the “too big to fail” issue. It indicated this would have to be something that would have to be considered as part of a case-by-case, situation-by-situation kind of review. I think that's appropriate, given the fact that it really is not possible to come to a precise kind of determination.

On your issue of globalization derivatives and so forth, there's no question that this is a challenging world; the complexity is out there. There have been other witnesses in front of this committee who have talked about some of the enhanced complexity.

The end of your question was about how do we do this without some kind of global oversight of some form or other. The reality is that in the banking system, for example, when we consider a Canadian bank that has operations, under the approach we take and the commitments we've made to other regulators in industrialized countries, we have a view on an oversight basis, on a global consolidated basis, of those organizations. That's why for example if there were to be holding companies, we want regulated holding companies, because we want to preserve that global consolidated oversight basis.

Obviously we will rely in part on what's going on in other regulatory jurisdictions; we'll rely in a major way on boards and management internal and external control systems. All of that is to say that there may well end up from time to time being losses as a result of this. This is not a business without losses.

Our job in part is to try to do our best to reduce the likelihood of those losses occurring, and when those losses occur to reduce the likelihood that those losses will be material enough that they will lead to the failure of the institution—without guaranteeing that we can do that in all cases. I would note that in the Canadian cases recently, given the volatility in financial markets, I would not expect Canadian institutions to avoid all losses. Some have indicated that they will have some losses.

On the other hand, we have had no announcements from major Canadian institutions around the fact that they have taken the kinds of hits that some other institutions have taken. Canadian institutions are broadly pretty well managed, and they have capital that's well above regulatory minimums, so I would not expect all losses. We're not looking at the same cases we've looked at in a couple of other circumstances around the world.

The Chairman: Mr. Valeri.

Mr. Tony Valeri: Thank you, Mr. Chairman.

I'd like to get a reaction here. I'm going to draw upon the testimony of Mr. Mackenzie, who had come before the committee. He made reference to the fact that the report describes many institutions that are functioning in the market but it specifically excluded security dealers and investment bankers. In fact he went on to say that in recent weeks, about a month ago, he talked about American banking and security regulators being able to coordinate and make a decision, somewhat controversial in some areas, affecting both commercial banks and investment houses with respect to the near failure of the long-term capital corporation. He stated he doubted whether such coordination could actually occur in Canada, and he actually went further to say it is likely OSFI may not fully understand the banking industry's exposures to the securities market's volatility. He went further to say he understood the MOUs were there with the provinces, but he really felt this wasn't enough. How do you react to that?

• 1920

Mr. Nicholas Le Pan: Let me start from the back and work to the front.

I don't think we're really operating entirely within the kind of MOU world, because the world's moved on since those MOUs were entered into. The modelling that's used to estimate the value at risk for traded portfolios is a model in institutions that's used with respect to the banks' exposures, the security dealers' exposures. We have to assess that model for capital purposes. We do that. We're doing that with respect to operations across the whole of the enterprise for both the dealer and the bank.

Another example is that if there is a control system issue, the question of where the line is on the trading floor as to what trades are being done on behalf of the bank versus the dealer really isn't relevant from our perspective. We're obviously cooperating with the securities regulators; we're sharing information. There's no question more could be done, in the sense that Mr. Mackenzie indicated we have a challenge to continue to keep up to do the best we can. But I don't think it's— As a practical matter, we've tried to adapt to the fact that the businesses have adapted, and the strict separation between what the bank does and what the dealer does really isn't there as much as it was before.

Now on the question of the Federal Reserve's role, my bottom line there is that I think if we and other federal regulatory authorities—the Bank of Canada or whoever—called the meeting that the Federal Reserve did in Canada, institutions would come. That's my bottom line on that one.

Mr. Tony Valeri: So you feel you would be able to provide that same type of coordination.

Mr. Nicholas Le Pan: I beg your pardon?

Mr. Tony Valeri: You would be able to provide that same type of coordinated approach.

Mr. Nicholas Le Pan: Well, if there were a potential issue that would affect the system, the major banks and the major dealers would try to manage that, because they have as much incentive as we and other players in the system, such as the Bank of Canada, do under a lender-of-last-resort responsibility.

Mr. Tony Valeri: Okay.

The second question I had makes reference to testimony that I believe Mr. Rousseau provided from the Laurentian Bank. It has to do with what your brief refers to on page 14 with respect to the inconsistent treatment of goodwill. The way he explained it was if I go out and I purchase another financial institution in Canada, we go with the market value. I perhaps have a bump up, which is looked at in terms of goodwill. The Institute of Chartered Accountants treats it as such. It's an asset. I get to deal with that in terms of depreciating that asset. But in terms of the regulatory aspect, I cannot use that asset for capitalization purposes. Call it an inconsistency. It's not the same in the U.S. It's not the same in the U.K.

You indicate you would be pleased to advise that action has already been taken along these lines, and I'd like to give you an opportunity to address that.

Mr. John Palmer: Mr. Valeri, the issue Mr. Rousseau was raising is a genuine problem. We've been concerned about that. We announced in the late spring that we were looking at this, and that if the Canadian Institute of Chartered Accountants was not in a position to change its standards to address this issue, then we were prepared to use a power we have under the financial institution legislation to prescribe accounting rules for financial institutions. I'm going to ask Nick Le Pan, who headed up this project, to tell you where the matter has now moved to.

Mr. Nicholas Le Pan: We'd be happy to provide the press releases from both the CICA and ourselves to the committee afterwards if you haven't had them, because that's a good one-page summary of where this is at.

Broadly, the MacKay report recommended the CICA give accelerated consideration to levelling the playing field between Canada and the U.S. with respect to these accounting rules, and if that were not possible, that we use our special powers to create that levelling of the playing field on an interim basis until accounting regulatory bodies could get their act together.

• 1925

The CICA announced about two weeks ago that they have an accelerated process involved to try to bring this to a close by the fall of 1999. We announced that we welcome that. We think that is actually the best solution, because it could apply to all institutions, not only the ones we regulate. We also announced that we would be ready, if it became clear that they were not going to meet that objective, to use our powers to the fullest extent we could to achieve that solution.

However, we can only achieve, unfortunately, a partial solution, because there are some entities for whom our powers do not apply. Our powers only apply to regulated institutions. There are unregulated players who might like to make acquisitions and for whom we couldn't solve the problem.

So that's where it sits. I'm hopeful that the accounting standard setters will be able to do what they've indicated they're going to do on an accelerated basis. We will be monitoring the situation very closely.

Mr. Tony Valeri: When Mr. Rousseau said that in essence what you're seeing today are mergers of equals, essentially, because of the inconsistency and the treatment of goodwill, what you were saying today is with this accelerated treatment you now may have intentions of mergers of unequals, and they would be treated the same as in the United States—

Mr. Nicholas Le Pan: Yes.

Mr. Tony Valeri: —as long they're regulated.

Mr. Nicholas Le Pan: Be careful.

Mr. John Palmer: The treatment that is likely to result from the process the CICA has under way now will not be identical to the treatment now followed in the United States. But it will close the gap between Canadian institutions and American institutions. Furthermore, there is a parallel process now under way in the United States under which the Federal Accounting Standards Board is looking at revising the American standard, the standard that allows pooling of interest, non-recognition of goodwill across a very wide range of transactions.

I think there is a reasonable prospect that the Canadian standards, or the change in the Canadian standard the CICA is working toward, might be followed two or three years hence by a change in the American standard under the FASB process.

Mr. Nicholas Le Pan: If I might add, the current rules for example favour mergers of relative equals compared to unequals. They tend to favour share deals over cash deals for assets. So there are quite a few biases in the existing rules, which are clearly not neutral either between types of transactions or between Canadians and Americans, for example.

Mr. Tony Valeri: Thank you.

The Chairman: Mr. Szabo, you have a final question?

Mr. Paul Szabo: Final question? It's too bad. We need more time.

Mr. Palmer, your predecessor spoke to us in Toronto. Other than some cautions about Y2K and maybe the payment system, he was quite buoyant about the picture or the vision that MacKay's report laid out and was quite optimistic about the benefits. However, he's not the incumbent, and he doesn't have to deliver. He's not accountable.

I can understand you are going slow, and I can understand you're a little uncomfortable at the prospect of having to straddle a four-foot fence when your legs are only three feet long.

I was really taken by this issue of whether OSFI was going to be able to do the job in its present configuration and with its present mandate. It is another spectre that has been brought before the committee. I think it's extremely important, because it's changed, so it's change management and it's risk management, and it concerns me. The line of logic is that increased competition causes increased risk, which means higher risk of failures and obviously more costs.

This morning Mr. Godsoe from the Scotiabank said that if you increase the regulatory burden in the sector, that will provide substantial barriers to entry into the financial services sector. So now we've got a problem, because if we can't increase competition, we can't satisfy MacKay's premise. You're not going to be able to do your job unless you increase regulation. This is now a vicious circle, and I don't know how we get out of it.

It seems to me that you have to break this loop. I understand balance, but if we can't get to the competition side, the rest of this stuff is academic.

• 1930

Mr. John Palmer: I think that's an important question and really goes right to the heart of what the MacKay task force is talking about.

First of all, let's understand that our message is not saying don't do this. The argument Mr. MacKay puts forward is really based, as we understand it, on the premise that Canada has a very safe and sound system now. Most of the international surveys say that we rate among a very few countries in terms of the safety of our system, the soundness of the system, the ability to protect the savings of depositors and policy holders.

He's saying, if I read the report correctly, that because our system is not seen as open to new entrants, as accessible as some other systems, maybe it's reasonable for us to shift the balance and to give up a little bit in terms of safety and soundness and the ability to protect the savings of Canadians in order to increase ease of entry, increase the number of players in the system. That's an entirely legitimate proposition.

Our message in respect to that is if we do that, let's understand what we're doing and let's make it clear to Canadians what we're doing, and don't put OSFI in the untenable position in which you say to Canadians that the level of protection, no matter which institution you deal with, is just as good as it always was, while at the same time raising the difficulty of regulating and supervising.

It would be legitimate for the government to simply accept the broad thrust of MacKay without doing anything further. But I think it's also fair— Another response would be to say all right, we're going to do much of what's recommended, but we are also going to look at regulatory and supervisory powers to see if some additional powers should be conferred to permit OSFI to deal with the new entrants, to deal with the increased risks in the system.

The powers to deal with holding companies, for example, which are referred to in that particular report—is that going to add such a cost of regulation that it will discourage new entrants? I would say not necessarily. First of all, I think by comparison with many other countries, our regulatory system is not particularly costly now. I doubt that regulation alone serves as a significant deterrent to anybody coming into Canada. The real deterrent for institutions has been the fact that they can't make any money, oddly enough because of ferocious competition in certain highly active markets, retail markets, consumer lending markets within Canada. That doesn't mean a lot of players; it simply means ferocious competition among the existing players. So I don't think regulation is currently the reason why people don't come into the system.

Further, even if our powers were enhanced in certain areas to deal with the need for example to achieve the speedy exit of those new entrants to the system that don't succeed, I don't think the overall level of regulation and supervision of regulatory burden needs to be increased.

We know there are some things we can do to streamline the system now. Nick and his group in the supervision sector are rolling out a new supervisory model, which is more risk-based, which means that for the institutions in good financial health, they're going to see us less. We're going to be carrying out fewer of the routine transactions. We know there are things we can do to streamline reporting. We know there are things, and they're referred to in the task force report, to streamline the approval process, which is currently very cumbersome.

Even if there is a wish to respond to some of the concerns we're raising by providing appropriate powers to deal with the enhanced risk, I don't think we need to end up with a system that overall creates more regulatory and supervisory intrusion than it does at the present time.

The Chairman: Mr. Le Pan.

Mr. Nicholas Le Pan: Just to come back to your apparent conundrum we've got to get out of, part of it would be simply accepting, which we already accept, the fact that if an institution fails it doesn't necessarily mean the regulatory system has failed. We do have protection, as you know, for smaller and medium-sized individuals so that they aren't unduly hurt.

• 1935

If we change where we are on the risk regulation curve to get more competition, maybe there are going to be a few more of those. But maybe that's okay, without causing public confidence in our system, which is very high now, to fundamentally erode. Maybe over some kind of cycle it would be okay that we had more of that, without going to the S and L experience. But we've had a pretty good system from a safety and soundness point of view, and as long as we're adequately protecting smaller and medium-sized players, maybe we're prepared to accept a bit more risk and the implications of that in the system, in order to get more competition. That's not the end of the world.

Mr. Paul Szabo: That's spooky.

Mr. Nicholas Le Pan: Why?

Mr. Paul Szabo: It's spooky because perception of the public is extremely important to all of us. If Canadians feel that some banks are too large to fail, the banks will know that. The banks will then expand their risk scenarios as well. Therefore in the whole system there tends to be this ripple effect.

To suggest that a few more failures shouldn't really have much effect on Canadians— I think Canadians right now are very sensitive to what happens in the banking sector, particularly since a hell of a lot of Canadians don't live in urban centres. They expect those smaller institutions to be secure.

Mr. Nicholas Le Pan: There's a real issue around the importance of systemic versus not.

John, did you want to—

Mr. John Palmer: Yes. I think this is a fundamental question, and it is worth spending a few minutes on it.

We do have a system now—and this is clearly stated in our mandate—that institutions can fail. We are not seeking to run a failure-proof system. In order to protect Canadians, we have deposit insurance, and there are industry compensation funds in the insurance industry to deal with these. So the system as a whole is providing a minimum level of protection to Canadians and their savings, to click in when these failures do occur, and there have been failures. Although there have been some concerns raised when these failures have occurred, the system has gone on.

It's fundamental, if we understand the recommendations of the task force, that the task force is saying we should be prepared to accept more risk, and by implication, more failure—not necessarily a lot, but more. If I understand them correctly, the ownership rules are designed to deal with or at least to raise the possibility that there will be more failure, but at the lower end of the size spectrum.

The task force is proposing widely held ownership for the large institutions, whose failure would have systemic implications. Widely held ownership is not just a Canadian ownership rule; it's a safety and soundness rule because, all other things being equal, widely held institutions tend to be safer than closely held institutions.

But at the smaller end, he's saying we can afford to take a few risks in order to create more entrance to the system and more competition than we have now, because clearly what he's heard is that Canadians want to see more players.

You may not be able to have your cake and eat it too here. That's the policy issue you all have to wrestle with, and boy, it sure isn't easy.

A voice: And we can choose one or the other.

The Chairman: Mr. Gallaway.

Mr. Roger Gallaway (Sarnia—Lambton, Lib.): Thank you, Mr. Chair.

We had a witness before us in Vancouver who talked a lot about derivatives. I don't know the first thing about them, but what he portrayed is a financial tool, if I can call it that, whereby there's great risk and there's great numbers of dollars that are wagered—and I know that's not the correct verb. No one really understands this except some mathematicians who are employed by banks, and he referred to a book that has been written about it, which portrays it as being a very high-risk business that's being carried on by the banks.

Is the issue of derivatives high risk? If so, what do you do to monitor it? What sorts of conditions do you place on banks, in terms of reserves or other safeguards to protect people?

Mr. John Palmer: First of all, derivatives can be high risk or low risk. Derivatives are all around us. Some of the enhanced GIC's that you buy now from banks, which offer a market index return, are in fact derivatives. Many of the segregated fund products that you're buying from insurance companies have derivative components within them. Many of the mutual funds you buy that allow you to get foreign exposure while still meeting the Canadian content requirements in your RRSP use derivatives to achieve that.

• 1940

For the most part, these derivatives have a low risk and are well understood. But there are also some very complex derivatives with a multitude of conditions that are indeed only understandable by mathematicians. We learned from long-term capital management failure that even the mathematicians may not understand the full range of impacts of those particular derivatives.

We're not going to banish derivatives. They're part of our financial sector. They're with us forever, and we have to find a way of coping with them. The financial institutions cope with them by attempting to put in place adequate controls within their organizations. There are the internal audit groups. There are models that calculate the bank's or financial institution's exposure at any particular point in time across all of its derivatives and other market-based positions they have. Their directors receive regular reports from the risk management groups in their institutions on how the risk to the institution is being managed. Many boards have been offering courses to their directors so they can understand more about the nature of derivatives and the risks that the institutions are taking on.

This is a work in progress. Mistakes are being made. We've seen the exposures that some of the institutions had with respect to long-term capital management, and more recently, in terms of one institution with respect to another derivative trading company, D.E. Shaw.

No one understands these perfectly, and some institutions have been too aggressive. We're quite comfortable, without suggesting to you that we have a complete knowledge of everything that's occurring, that Canadian institutions are being cautious in this area. Long-term capital management was an interesting test. Some Canadian institutions did have positions in long-term capital management, but they were small. They weren't even in the group of thirteen institutions who were called in to negotiate the rescue, if you like, of long-term capital management. These were very small positions.

So this is a work in progress for the institutions and for us. We have in place now a capital markets group that we started up about a year and a half ago to review the banks' value-at-risk models that they use to control their exposures. We staffed that with a group of some internal people and some mathematicians we recruited. So we're trying to follow these developments. We're still playing a bit of catch-up ball. So as I say, there are going to be some mistakes and losses, but I'm not uncomfortable about the way things are unfolding in a Canadian context.

Mr. Roger Gallaway: You're not also uncomfortable about the exposure either.

Mr. John Palmer: I'm not uncomfortable about the overall exposures in a Canadian context at this stage.

Mr. Roger Gallaway: Yes.

The Chairman: Mr. Palmer, in reference to Mr. MacKay's vision of a more sort of entrepreneurial system, I understand some colleagues are concerned about safety and soundness and the fact that you may have failures, but quite frankly, how many businesses are guaranteed success when they start in the financial services sector or anywhere else on this planet? Is that the trade-off you see?

Mr. John Palmer: I think that's the trade-off. I think there's more to it even than, Mr. Chairman. If you believe in market discipline, there have to be consequences of running your business badly. If we were seeking to run a failure-proof system, a system in which no institution ever failed, we would have such powers that we would step in to prevent risky behaviour.

• 1940

Even if we had the competence to do that, I think you'd pay an enormous price. You'd pay a price in terms of loss of innovation, loss of risk-taking, loss of efficiency, loss of quality of service to Canadians. There would be a kind of moral hazard in that people would feel they could make unwise decisions while recognizing that the system would ultimately step in and in some way bail them out.

So I think our system, which does contemplate failure but has a number of mitigants to protect the victims of failures, is basically well thought out and well designed. I think the recommendations of Mr. MacKay are consistent with that line of thinking. He does shift the balance, and we talked about the consequences of shifting the balance and the importance of understanding those consequences. But I think we would basically support the current design of the system, with its acceptance that some failures must happen.

The Chairman: Doesn't this also reflect the era we live? As you move toward a technologically based society, an innovation-based society, doesn't it in essence have to become more entrepreneurial by the very nature of that society?

Mr. Nicholas Le Pan: Yes, and I think that's happening. I think part of what MacKay's doing is suggesting ways in which we could make it more possible for that to happen faster and in a more vibrant way here.

The other related thing that we talked about in our opening statement is that there are other mitigants. There are also issues of whether or not more could be done on things like disclosure to give people more sense of helping themselves assess the situation, while we continue to make sure we don't end up with problems that become system-wide problems that cause the big, huge problems that we've seen in some other countries. We've successfully avoided them here, and I think we can continue successfully to avoid them while still perhaps moving the balance the way MacKay is talking about.

The Chairman: Thank you.

Mr. Brison, you have the final question.

Mr. Scott Brison: Paul Krugman, of MIT, did a study recently, a post-mortem on the Southeast Asian crash. He blamed a lot of it on under-regulated banks, and asserted that competition among over-guaranteed and under-regulated banks leads bankers to not base decisions on the project's expected return. In fact, this whole process of under-regulated and implicitly guaranteed banks creates a sense where banks, bank directors, bank management will take risks that they would not otherwise take. These risks perhaps inflate, for instance real estate in Southeast Asia. That's a real risk, particularly if you look at the compensation packages of banks that are focused largely on quarterly or annual returns and that sort of thing; it's the short-term returns.

This debacle that occurred in Southeast Asia could occur in Canada. It could occur in almost anywhere where we have implicit guarantees. Now, I know you say that the guarantees are really not there, that they're not an exact guarantee. For most Canadians, though, there is an implicit guarantee that our banks are going to be bailed out if there were a problem, particularly in light of these derivatives and the other complex financial tools that really are almost impossible to regulate.

Mr. John Palmer: Mr. Brison, the issue you're raising is hugely important to Canada and to the world.

• 1950

I've read the article summarizing Mr. Krugman's views. While I'm in general agreement with the comments he makes, let's understand that the quality of financial institution and bank regulation around the world is very uneven. There are countries in which it is very poor. There are countries in which supervisors, regulators, have very few powers, have very little knowledge, don't get the support of their governments, and are operating in systems that are inherently corrupt. In those circumstances, the issues that you raise can do an awful lot more damage than they can in systems in which those conditions are not present.

It is also a fact that although the quality of regulation is probably not perfect in any industrial country, there is an enormous gap between the quality of regulation in the countries that have had difficulties and countries like Canada, the United States, and the countries of western Europe, where these sorts of difficulties have not risen to anything like the same extent. Regulators in those countries do have significant powers, do get the backing of their governments, and corruption operates at a pretty minor level within those societies.

So as a general statement, the risks of those sorts of issues occurring in Canada are relatively small. That isn't to say we're insulated from the issues in Asia. We've seen a kind of domino effect in the markets. That needs to concern us all, and we need to prevent recurrences of the sort of issues that have been occurring in Asia. One of the priorities of the government—one in which we have been very much involved—is to work with the IMF, the World Bank, and the Basle committee on banking supervision to see if we can work to improve the standard of regulation and supervision in some of these countries quickly and dramatically.

Nick, do you want to take on the second part of that?

Mr. Nicholas Le Pan: Yes, I'd just like to add two points on Asia by coming back to a couple of other points you made.

You asked the question about market discipline in the context of supporting debt. There already is more market discipline in the Canadian system than there has been in a number of those Asian countries.

Secondly, regulation in many countries depends not only on what the regulator or supervisor does, but on the rest of the infrastructure. The legal accounting infrastructure in a number of those countries is far inferior to what it is in a number of industrialized countries, including this one. We're not just talking about situations that arose because of regulators, we're talking about situations that arose because of market discipline not being there to the same extent it is here, because the extent to which accounting rules and treatments of bad loans and so forth was nowhere near what it is in Canada. Those are further reasons why I think the conclusion is a valid one: that it's not transposable between what happened here and what might happen here.

The Chairman: Thank you, Mr. Brison.

On behalf of the committee, Mr. Palmer and Mr. Le Pan, thank you very much. We extended this sitting here because you have very interesting points of views to share with us. They're obviously useful, as was your briefing to us before we started to criss-cross the country, by the way.

We're going to suspend for two minutes, and then we'll be back.

• 1953

• 2002

The Chairman: I'd like to call the meeting to order once again, and welcome representatives from the Canadian Payments Association. With us are Mr. Robert Hammond, general manager, and Mr. Doug Kreviazuk, director for policy and planning.

Welcome. As you know, you have ten minutes or so to make your presentation, and thereafter we'll engage in a question and answer session.

Mr. Robert M. Hammond (General Manager, Canadian Payments Association): Thank you, Mr. Chairman. We're delighted to have this opportunity to appear before the committee.

We've distributed a copy of our opening statement, but I'll just take a very few minutes to go over the highlights.

Three weeks ago the CPA board met to review the July 1998 Department of Finance payments system review discussion paper, and the three recommendations in the MacKay task force report relating to the payments system—and those were recommendations 13 to 15 in the MacKay report. The recommendations deal with CPA membership requirements and governance of the CPA from the perspective of public policy oversight. In summary, the board's reaction to those recommendations is very positive. The board has asked me to emphasize that CPA members welcome the review of the payments system.

The CPA was created by an act of Parliament in 1980 to operate the national clearings and settlement system. The CPA Act has not been revised since that time, and it needs to be updated to reflect today's circumstances. The CPA has prepared five papers on the issues being discussed in connection with the payments system review, and we have provided those papers to the Department of Finance payments system advisory committee. We have also provided those papers to the task force, and tonight we have given you a second handout that summarizes the positions that are expressed in those papers.

The current CPA Act limits membership in the CPA to the Bank of Canada, the banks, the trust and loan companies, the centrals of the credit unions and Caisses populaires, and the other deposit-taking institutions. We currently have 128 members, over 60% of which are non-banks. Interestingly enough, about 30% of our members are provincially incorporated and regulated financial, deposit-taking institutions, including such important organizations as the Caisse centrale Desjardins, the Alberta Treasury Branches, and the credit union centrals of most of the provinces.

Since the views expressed in our opening statement represent a consensus position of the CPA board, I think it's important for you to know how our directors are chosen, and who they are.

• 2005

The act calls for an eleven-person board. The Bank of Canada appoints one director, and that director must be the chair. Five directors are chosen by bank members, and five directors are chosen by non-bank members. For each director chosen, the appropriate members also choose an alternate director.

Alternate directors are invited to attend all board meetings and participate in the discussions, and you'll note from the list that was attached to our opening statement that the 22 directors in total include officers from different types of small and large, provincially and federally regulated deposit-taking institutions.

Now I'd like to touch on the three specific recommendations in the MacKay task force that deal with the payments system.

In recommendation 13 the task force recommends expanding CPA membership. I want to emphasize that early in the review process the CPA made it known that it had no objection in principle to expanding membership in the CPA. However, it suggested that when doing this, the decision-makers should be careful to consider the ramifications for the attributes of the Canadian clearing and settlement system that Canadians value so highly, and that is, its efficiency and its safety.

While the task force report states that expanded access to the payments system is vital for strengthening competition, it also recognizes that increased participation will require careful review. Both the task force report and the finance discussion paper suggest that the criteria for deciding on access should focus on regulation and supervisory oversight, access to liquidity support, the appropriate legal framework in the sense that the laws governing the new participants in the payments system must be compatible with payments system activities, and lastly, operational and technical competency. These are the criteria that the MacKay task force mentioned, and the CPA agrees completely with these criteria.

The specific task force recommendation is that the CPA Act be amended to permit financial institutions other than deposit-taking institutions to become CPA members on designation by the Minister of Finance if they meet the suggested criteria that I mentioned earlier. The recommendation also states that the Department of Finance, working with the CPA, should give high priority to determining the classes of financial institutions that would be eligible. The CPA welcomes the suggestion that it work with the Department of Finance on this matter, and it looks forward to making a contribution.

Now I'd like to turn to the governance issues. Documents that were prepared for the payments system advisory committee suggest that there is a perception by some that some CPA decisions may have favoured the interests of its members over others. The concern is that perhaps the decisions that are being made aren't being made in the public interest.

The finance discussion paper describes some options for strengthening the governance of the CPA, and the task force report makes two recommendations for strengthening oversight.

To put the task force recommendations and the finance discussion paper options in perspective, I'd like to take a second to describe the measures currently in place to ensure public policy oversight of the CPA.

First, CPA bylaws regarding clearing and settlement matters must be approved by the governor in council before they come into force. The act then says that the board has the authority to make rules dealing with clearing and settlement matters, provided these rules are consistent with the bylaws. But interestingly enough, the chair, who is an officer of the Bank of Canada, has the authority to determine whether or not a rule is consistent with the bylaws.

Another requirement of the act is that the superintendent of financial institutions visit the CPA at least once a year and carry out an examination and then report to the minister whether or not the CPA is complying with its legislation, the CPA Act, and the bylaws that have been approved by the governor in council.

Although not required by the act, the CPA board has also taken two additional measures to strengthen public policy oversight. In 1996 it established the stakeholder advisory council, which consists of representatives of payments system users and service providers. The council has direct access to the board and provides the board with advice on payments system matters. It also provides the board with advice on the consultative mechanisms that should be used for dealing with payments system users and service providers.

• 2010

In 1991 the board set up what's called the consultative committee, which consists of a subset of the board and a representative of the Minister of Finance, namely the assistant deputy minister in charge of the financial sector policy branch. The objective of the establishment of the committee is to keep the minister informed of payment system developments. The committee meets at least twice a year and exchanges information and views on payment system matters that have public policy implications.

One of the options in the finance discussion paper for improving the CPA governance structure includes clarifying the CPA's mandate, including setting out in the legislation the policy objectives that should be observed in operating the payment system. It also includes a proposal to support the stakeholder advisory council by requiring its existence in the legislation. It's not a requirement now; it's something the CPA has done on a voluntary basis. Another proposal is that the CPA board be expanded to include independent directors from outside the CPA's membership.

The CPA supports all of these options, and they're included in a corporate governance proposal I'll describe in just a minute. One option in the Department of Finance discussion paper for improving public policy oversight is to create a type of oversight body, perhaps at the Bank of Canada, the Department of Finance, or elsewhere in the government that would be required to review and approve all CPA bylaws and rules before they come into force.

It's interesting to note that the task force report didn't go that far. It recommended instead that the Minister of Finance rather than the governor in council have the power to approve the CPA bylaws. But it also recommended that the minister have the power to review all new or revised CPA rules and to revoke any rule or revision the minister determines to be contrary to the public interest.

Given the number of CPA rules, the very technical nature of most of them, and the need for the CPA to be able to respond quickly to emerging issues, the task force approach would clearly be more efficient than requiring all the rules to be approved in advance by a government body. Moreover, we think the task force approach would place the responsibility and the accountability for approving rules consistent with the CPA's legislative mandate, including the policy objectives we expect will be set out in the new legislation, squarely on the board, and we think that's where the accountability and the responsibility should be.

The third task force recommendation is that the Minister of Finance should have the power to issue a directive to the CPA to make a change to a bylaw, rule or operating practice the minister thinks is necessary in the public interest. Certainly the CPA would have no objection to that proposal.

Based on the review of the finance department discussion paper and the task force report, the CPA board has approved a proposal for building on and enhancing the CPA's existing governance structure and its oversight from the public policy perspective. Details of this proposal will be set out in a paper we plan to provide the committee some time next week—and we'll be sending a copy to the Department of Finance as well—but today I'd like to just summarize the highlights for you very quickly.

The first highlight is we believe there should be a clearer articulation of the CPA's mandate in the CPA Act, including legislative policy objectives. That's an important element. We think that's necessary and have suggested some wording that might be used in one of the papers we provided to the Department of Finance and the task force.

Second, we think the board should be expanded to include independent directors appointed through a process established by the government. The only directors on the CPA board now are directors elected by our members.

Third, we think a majority of CPA directors should be directors elected by CPA members to ensure that payment system knowledge and technical expertise are maintained at the board level.

Fourth, the election process for member directors should be such that it continues to ensure diversity and fairness of representation by type, size, region and regulatory jurisdiction of institution, with no one type of institution having a majority of member directors.

• 2015

Fifth, we think the existence and mandate of the stakeholder advisory council should be enshrined in the CPA act. As well, there should be a requirement the chair of the council be on the CPA board. We believe the chair of the stakeholder advisory council should be a member of the board.

Sixth, we think there should be a consultative committee that would consist of a subset of the CPA board, including both member and independent directors, the chair of the stakeholder advisory council, and of course a representative of the Minister of Finance. We think this consultative committee and its mandate should be enshrined in the legislation. The objective, of course, would be to ensure at an early date there would be an appropriate exchange of information and views on public policy implications of payment system issues between the CPA, the Department of Finance and the minister's representative.

Lastly, as recommended by the task force, we think the Minister of Finance should have the power to approve CPA by-laws, review and revoke CPA rules that are contrary to the public interest, and direct the CPA board to make a change in the bylaw, rule or operating practice the minister determines to be in the public interest. These are the recommendations that were in the MacKay task force.

In conclusion, the CPA believes it has established a safe and efficient clearing and settlement system that provides the essential foundation for Canada's world class payment system. As the task force report recognizes, the availability of payment services in Canada is excellent compared to other countries. We think with an expansion of CPA members in the prudent manner suggested by the task force, the strength and governance provisions that have been proposed by our board and the oversight measures recommended by the task force, the CPA should be able to continue to provide the necessary support for the world class payment system we have here in Canada.

We also think the new governance and oversight structure would provide the CPA with the flexibility and authority necessary to respond to emerging issues quickly, which seems to be so important in today's rapidly changing environment. At the same time, we think it would provide the public with reasonable assurance that public policy objectives are being respected in the decisions being made by the CPA board.

The Chairman: Thank you, Mr. Hammond, for a very detailed presentation.

Monsieur Desrochers.

[Translation]

Mr. Odina Desrochers: Thank you very much for your presentation, Messrs Kreviazuk and Hammond.

Mr. Hammond, you said at the beginning that you were in favour of the recommendations affecting you, namely 13, 14 and 15, but when we reached recommendation 14, you appeared to show little resistance when we spoke of assigning further powers to the Minister of Finance. How do you see this?

[English]

Mr. Robert Hammond: No, sir, in fact we're very supportive of the approach the task force put forward. I indicated one of the options in the Department of Finance discussion paper that was put out suggested there should be some sort of government oversight body established to oversee the operations of the CPA.

Under the proposal set out in this paper—it was just an option and not a recommendation—the CPA board, which now has the authority to approve rules respecting clearing and settlement matters, would have to go to this oversight body and have all the rules approved before they could come into force. Our board approves hundreds of rules each year; most of them are very technical in nature and don't have a lot of public policy implications. We're concerned that would be a time-consuming process.

We much prefer the recommendation in the task force report that suggests the minister would have the power to review new rules and any revision to rules, and if he decided they were contrary to the public interest he would have the power to revoke them. We much prefer that approach because we think we're building some safeguards into our system to ensure the public policy perspective is taken into consideration in making our rules. We're not concerned with the minister having that power because we think it wouldn't have to be used very often.

• 2020

We aren't enthusiastic about a system where our board would make decisions and then have to go to a government body to have them approved. We think the accountability and responsibility for making rules that are consistent with our legislative mandate, and indeed with the policy objectives we think will be set out in the CPA Act, should rest with the board, as opposed to having a two-step process. Then if the minister feels that anything the board has happened to approve as a rule is contrary to the public interest, he could revoke it. Remember we're also proposing that we will have a number of independent directors on our board. We will also have the chair of the stakeholder advisory council on the board. So we think there are lots of safeguards there.

[Translation]

Mr. Odina Desrochers: Are you not afraid, Mr. Hammond, that your organization would lose some of its autonomy if new powers were given to the Minister of Finance?

[English]

Mr. Robert Hammond: We think our organization is capable of dealing with the new world, as Mackay has recommended. They've suggested we work with the Department of Finance in terms of identifying the types of financial institutions that should be eligible for membership in the CPA. We think we can make a contribution there and are looking forward to assisting the Department of Finance in any way we can. Our organization has expanded in the last few years and we think we're capable of dealing with the new members and adapting to changing circumstances.

[Translation]

Mr. Odina Desrochers: Precisely, in view of the new members, you are making recommendations about your board of directors. Based on recommendation 13, insurance companies, real estate brokerage firms and other agencies would become members of your organization. How would these people be represented on your board of directors to ensure that they have a say in your organization?

[English]

Mr. Robert Hammond: Our proposal for the board is that it consist of a mixture of directors that would be chosen by the members and also independent directors that would be chosen in accordance with the process established by the government. I indicated that one of the important concepts we have with respect to the election of member directors is that the process must continue to ensure diversity and fairness of representation by type, size, region and regulatory jurisdiction of institution. If we have these new types of members in the CPA, we think they should be represented at the board level, just as is the case now. For example, we're limited to banks, trust and loan companies, credit unions, caisses populaires, and other deposit-taking institutions.

If you have a chance to look at our list of directors you'll see, as I indicated earlier, there are directors who are officers of very big banks and there are directors who are officers of trust companies associated with life companies or mutual funds. We have a wide range of directors, and the intention at the board is that the new system should maintain that diversity and ensure that the new types of members have a say at the board level.

[Translation]

Mr. Odina Desrochers: Thank you, Mr. Chairman. These replies are very helpful to me.

The Chairman: Thank you Mr. Desrochers.

Ms. Bennett.

[English]

Ms. Carolyn Bennett (St. Paul's, Lib.): I have a few little questions, but I'm going to group them.

As a newcomer to this committee, we've heard a lot and read a lot in MacKay about the payment system. There seems to be great appetite by people to become part of your group. I guess I just need to know where the risk comes from and how you handle it. Perhaps you could explain this large value transfer system to me, whether it has reduced the risk, and in terms of all of this risk, why everybody is so worried about new entrants.

Mr. Robert Hammond: There are a number of questions there. I guess there are really two types of risk that are of concern in the payment system. First of all, when consumers make payments they want their payments to be honoured, in other words they don't want their payments not to be honoured because the institution on which they are drawn can't meet its obligations. So I think that's an important element.

• 2025

In other words, if you're making payments, you want your payment to be honoured, and you want it to be drawn on an institution that you can expect to be able to honour the commitment to make a payment from your account.

Generally, at the time the CPA was established, it was only the deposit-taking institutions who were sort of taking in savings, and it was only those types of institutions that consumers were interested in using for purposes of making payments. Since that time, of course, you have the mutual funds; you have the broker dealers who now are taking in savings that people might want to use to make payments. But as I said before, you want to make sure that when people make payments those payments are going to be honoured.

The second aspect of concern is that as a result of making payments, at the end of the clearing and settlement cycle—and of course we get into clearing and settlement because, as you know, the payment may be drawn on one financial institution and I, as the receiver of that payment, deposit it in another, so this financial institution owes this financial institution money—there's a fair amount of exposure that builds up overnight, because under the existing system settlement doesn't take place until the next day. So the financial institution that's receiving those payments in the form of deposits, and particularly in Canada, where we give same-day provisional credit—in other words, you get access to those funds—you want to be sure that you're going to get the money.

Under the existing framework we've built up, the players in the system are generally limited in number, they've all been subject to the same sort of regulatory regime, they all know each other, and they've had good faith that they're going to get settlement at the end of the clearing and settlement cycle. So they've been willing to provide provisional credit, and so on, and they've been willing to assume that they're going to get their settlement, because they know that all the other players in the system are regulated the same way and are generally subject to the same supervision. But you do have that settlement risk, that you may not get your settlement the next day, that the financial institution on which the payments are drawn may not be able to honour its obligations.

Of course that then leads to the possibility— It's not only risk to the people involved in making the payment and receiving the payment, but it's risk to that financial institution, and that leads to our concern about systemic risk. Systemic risk would be when the failure of one member of the CPA to meet its obligations to another might in turn cause the second CPA member to fail, and that might cause another institution to fail. So that's the systemic risk aspect.

One of the main objectives of our large value transfer system is to reduce systemic risk. The large value transfer system is a new electronic system that's highly secure, and it's really for important and time-sensitive payments. It's risk-proofed and backed by collateral, and there's an ultimate guarantee by the Bank of Canada in the unlikely event that there's more than one failure.

But the bottom line is that if a payment goes through that system, there's guaranteed certainty of settlement. There's no question that the receiving institution is going to get its money, and as a result, the receiving institution can provide its clients with finality of payment. So the client can get the payment quickly, and it knows it's final. It can't be clawed back if one of the financial institutions that's part of a deal fails.

Ms. Carolyn Bennett: So the big transfers are less risky because they're based on collateral, whereas the other transfers are— Is the smaller risk managed by trust?

Mr. Robert Hammond: First of all, I should explain that the large-value transfer system won't start operating until January. The system is now working, but it's not fully collateralized; it will be in January.

• 2030

Yes, we believe the large-value transfer system will reduce significantly and practically eliminate the issue of systemic risk, but there's still the concern that if you are a participant in the payments system and you're receiving settlements with respect to these retail payments, first of all, any other party in the system has an obligation to try to make sure it doesn't incur any losses. It wants to be sure that it's going to get its settlement even with respect to the retail payments. I wouldn't suggest that not getting the settlement would be enough to bring the second financial institution down; nevertheless, it's a loss, and it doesn't want that sort of exposure if it thinks it's not going to get its money. It has a duty of care to its shareholders and depositors to try to make sure that it's going to be able to collect.

Ms. Carolyn Bennett: We've been hearing about the issues around this enhanced access for a long time. How long is it going to take to figure out what the new rules would be for new entrants?

Mr. Robert Hammond: Well, of course that's in the hands of the Department of Finance. They have to make the decision. But as I indicated, we're certainly willing to work with them to identify the concerns that might exist from the point of view of the safety and soundness of the payment system.

As I indicated, the MacKay task force identified the types of issues that have to be looked at. For example, there's the regulation and supervisory oversight of the institutions that want to be in the payment system, the whole legal framework that applies to them, and their access to liquidity.

interestingly enough, if you had a chance to look at it, the Department of Finance discussion paper has a section at the back of the report that identifies some of the issues that need to be looked at. We're in general agreement with those issues. I'm not suggesting for a moment that they're insurmountable, but there are a number of issues that have to be looked at. A lot of them relate to the legal frameworks that apply to these other types of institutions. We're not experts in that field, but we can talk about the ramifications for the payment system.

Ms. Carolyn Bennett: As my group crossed the county, there was a lot of conversation about direct and indirect clearers. I was surprised to see that the Western Bank is an indirect clearer. So what are the criteria for being a direct clearer? How many do we have? Are there people who choose not to do this?

The other part is from a consumer point of view. If you're an indirect clearer, aren't you paying fees to the clearer? Why wouldn't everybody want to be a direct clearer?

Mr. Robert Hammond: The requirements for being a direct clearer are set out in our bylaws. You have to account for 0.5% of the number of items that are cleared and settled by the CPA. We currently have thirteen direct clearers, which include the Bank of Canada, major banks, Caisse centrale Desjardins du Québec, Credit Union Central of Canada, Alberta Treasury Branches, some schedule II banks, and Canada Trust, of course. It's the major institutions.

Of course, as I indicated earlier, our legislation, in fact our clearing bylaw, hasn't been revised since 1980. At the time the CPA was established, we were dealing with mainly paper transactions. You have to appreciate that the cheque-clearing system requires a lot of infrastructure, and it made practical sense to have a two-tier system whereby you would have direct clearers and indirect clearers.

As we move forward into the electronic world, I think we all recognize that we have to sit back and look at that issue. Do we continue to need direct clearers in the electronic environment? That's something that will have to be reviewed in the context of the review of the act and indeed our clearing bylaw.

There may still be reasons why some people will want a direct clearer. When you have a direct clearer, that direct clearer assumes liability for your clearing obligations. If you're a small player and not well known, there may be some nervousness in the system about whether or not you're going to be able to meet your obligations. So if you go through a direct clearer, the other players are going to be perhaps more willing to take the obligations because they know that one of the major institutions has done a risk assessment and is prepared to stand by your clearing and settlement obligations. So there may still be room for a direct clearer in some circumstances in the new environment, but perhaps more indirect clearers will be able to become, in essence, direct clearers.

I should have said that to be a direct clearer, you also have to have a settlement account at the Bank of Canada, because that's where settlement takes place.

• 2035

Ms. Carolyn Bennett: I was wondering where we were in terms of looking at the future of financial institutions five or ten years down the road. Do you have any predictions of what that would look like?

Mr. Robert Hammond: Let's look at electronic transactions. Again, this is subject to the Bank of Canada being willing to grant all these members settlement accounts. But if that's the case, I would expect perhaps that we'll have more flexibility with respect to electronic transactions and we won't necessarily have to use the two-tiered approach if a particular institution doesn't want to.

The 0.5% requirement will change. That was a very practical requirement at the time. In fact, if you go back to 1980 and look at the range in the size of institutions, there was sort of this one tier that was very big and then there were all the others. We've got to remember that the direct clearers' own transactions, in terms of the number of transactions that go through the system, account for at least 97% of the number of payments. So that just shows you that we have a group of bigger institutions and a group of much smaller institutions in terms of the payments business.

Ms. Carolyn Bennett: So are there specific criteria to become a direct clearer?

Mr. Robert Hammond: Yes.

Ms. Carolyn Bennett: ING seems to be upset that they're not a direct clearer.

Mr. Robert Hammond: Under the existing rules, they have to account for 0.5% of the total number of payments that go through our system. They aren't near that yet because they're a relatively small institution. That's the problem. As I was saying, we have to look at that requirement as we go forward.

The Chairman: Mr. Valeri, do you have a question?

Mr. Tony Valeri: Mr. Chairman, I just have a very quick question with reference to ING. Apparently, initially, one was able to transfer money electronically from one of the chartered banks to ING. If I were a customer at CIBC, I could have called them up to ask them to transfer money. Then you came into the picture and said I couldn't do that. Now what happens is that I can write a cheque to ING that I can have ING transfer directly to CIBC, if that's my bank. Why is that?

Mr. Robert Hammond: Well, this relates to what we call rule H4. That's the rule that relates to pre-authorized debits. Pre-authorized debits are really a system where third parties can come into your account at a member CPA institution and take money out. It's called the debit pull approach because the institution that's going to receive the money goes into your account and takes the money out. This is as opposed to a credit push approach, where, if I have an account at a financial institution, I will instruct them to make a payment on my behalf.

Rule H4 has prohibited one-time debits or sporadic debits. We have a rule that accommodates regularly recurring pre-authorized debits subject to certain limits and indeed a lot of safeguards to protect the consumer. This done because somebody else is coming into your account and taking money out.

I have to say that we did not stop ING in the sense that there was never a rule that accommodated the type of transaction they were doing. Our rules didn't accommodate that type of transaction. What happened was that they weren't complying with the existing rule.

But at that time—this happened about a year ago—the board recognized that there should be a way to permit this sort of transaction to take place with appropriate safeguards to protect the interests of the depositor. So we have set up a working group. I can ask Mr. Kreviazuk to explain in detail what we're doing. We're now moving forward with a proposal that will facilitate the type of arrangement that ING wants with the safeguards that will protect the depositors and also the institutions that hold the funds, because they have a duty of care to their customers to ensure that these transactions are authorized.

Maybe you could just explain what's happening, Doug.

Mr. Doug Kreviazuk (Director, Policy and Planning, Canadian Payments Association): As Bob pointed out, about a year ago, further to these concerns coming to our attention, we set up a working group representing our members, but also we included representatives of our stakeholder advisory council, and we have representatives from IFIC, the Investment Funds Institute of Canada, and from the consumers group on our working group.

• 2040

The purpose of this has been to try to facilitate a funds-transfer mechanism that achieves the safeguards to consumers and to member institutions, but also provides these regulated institutions or CPA members the flexibility and efficiency to transfer funds on an intra-member or intra-institutional basis.

As of now we've been working on a proposal whereby regulated financial institutions—which would go well beyond CPA members—could in fact draw on CPA members in a one-time debit. There would be certain safeguards, similar to what exists today under rule H4. It would permit the scenario ING has brought to your attention.

The Chairman: Are there any questions?

Mr. Hammond and Mr. Kreviazuk, on behalf of the committee I'd like to thank you very much. It's clear from your presentation that we have a world-class payment system here in Canada, and that essentially any expansion will require strength-in-governance provisions. That's very clear. I'm sure that members of the committee will take note of that as we make recommendations to the Minister of Finance. Thank you very much for your presentation.

I'd like to welcome several witnesses from the Interac Association: Judith Wolfson, president; Fred Harris, senior vice-president, service delivery; and Marc-André Lacombe, corporate secretary and legal counsel.

Welcome back to the finance committee. We thoroughly enjoyed your last presentation. We've been talking about it ever since. It's really been quite helpful, and I'm sure that you have more things to tell us tonight. Welcome.

Ms. Judith Wolfson (President, Interac Association): Thank you, Mr. Chairman. We're delighted to be back and have an opportunity to respond again before the committee.

As you noted, we did have the opportunity to present before. Now that the report of the task force on the future of the Canadian financial services sector has been released, it gives us an opportunity to do that. Indeed, let me just begin by saying that we consider the report to be very forward-looking and important in looking at consumers and the whole issue of this sector.

We have provided you with some slides. I hope these will be helpful as I go through the presentation. In light of your time I'm going to try to go through the presentation very quickly, and it will be highlighted here.

You requested that we return to do two things. First, we should offer our vision of the future of payment services, and talk about what it will look like in the future. You also asked us to speak to those specific recommendations to be made the following day in the task force report that would have a direct impact on Interac. So we plan on doing that, but before we do, I'd like to just take a moment to reorient the members of the committee to the Interac network. I will also review just a few of the messages that we left with the committee the last time we were here.

• 2045

With regard to the Interac background, the network began in 1984 as a loose collection of five financial institutions. They realized that they could offer consumers better access to their money by pooling their resources. Indeed, as we mentioned at the last session, between 1984 and today there has been an astronomical growth in this kind of opportunity. That hasn't changed. Interac has grown to 62 members today from five. They lever national access to 21,000 bank machines and almost 375,000 points of sale.

I think all of us would agree that consumers have embraced the network. It really has become a part of our everyday existence in an extraordinarily short period of time. On a per capita basis Canadians use more ATMs than any other country in the world. In only five years since the introduction of the debit service Canadians have the third-highest number of debit transactions per inhabitant. So really it is an extraordinary story.

The network was built within the regulatory framework of the day, of payments in the 1980s and 1990s, including the CPA Act, the Bank Act, and the Trust and Loan Companies Act. They currently prescribe who can take certain activities. Other presenters have told you what that regulatory framework looks like.

In addition to that basic regulatory framework, we are governed, however, by a 1996 Competition Tribunal consent order that was negotiated between Interac and the Competition Bureau. That order governs many aspects of the association. I'm going to elaborate later on the major effect it's had on the way the network operates. But before I do that, I want to come back to the first request you made, on the future directions of payments in Canada. Perhaps I can blue-sky a little for you.

Unfortunately, we have no crystal ball. I guess we could all make a fortune if we did. And we can't give you all the answers about where technology and consumers will drive changes in payments in the next century. The pace of change is really too great to know what will emerge tomorrow. However, we can share some of our perspectives and directions with you.

The most fundamental observation that needs to be made is that consumers are moving beyond traditional payment methods. Certainly we are moving beyond the cheque, which is the very basis of the architecture of our payment system up to now.

We believe that we are only in the early stages of this transformation. Although for the consumer in Canada it looks like a huge transformation, it really is the first step in a long road.

It's very important for us all to note that consumers are driving this change, and we see that because they are embracing the results. We've had to expend very little effort to get people to accept the change, and it's an environment ripe for innovation.

We don't anticipate that cheques will disappear. I remember last time we were here you asked the CPA whether paper was going the way of the dinosaur. Our research shows that cheques continue to be important instruments for certain purchases, but they are losing ground to electronic payment methods.

There are all kinds of by-products of this shift—for example, continued growth in the number of loyalty programs attracting users to new payment instruments. We also are seeing, and expect to see, more new payment methods such as stored-value cards and multi-application cards.

And the challenge for innovative payment providers like Interac is to continue to deliver convenient, high-quality service in electronic payments. This should match the success of Canada's very efficient paper-based cheque clearing system, and, I would say immodestly, the world-leading system of ATMs and debt payments at the point of sale that Interac has been able to bring forward. And to do this, to continue that growth, we have to be very forward-thinking. We do not want to build systems for yesterday. We have to build systems for tomorrow.

• 2050

So we do need to have a little clairvoyance. We do need to be able to look at that crystal ball and say this is what consumers are asking for, this is what they're demanding. We know it because this is what they are embracing.

Certainly if I had a perspective for Interac to bring to the table, it is looking at the next steps, but in a way that's searching for what people will want tomorrow, not the past, not what they've had. It's evident that consumers want to embrace that innovation.

You can see the evidence of those patterns over the past four years, and you can see how cheques are declining in usage. It's not an overnight revolution, but it's a gradual change in spending patterns. Cash is clearly still the most popular method of payment.

If we want to look at that issue of cash for a moment, it's interesting to look at some facts about low-value transactions. About two-thirds of all transactions are under $20. A recent survey we looked at showed that 88% of those low-value transactions were made with cash. We anticipate significant opportunity for innovation in high-volume, low-value payment methods, since they account for such a large percentage of transactions. Stored-value cards may fill a part of this need.

In addition to consumers, retailers are part of the payment revolution. For example, one large retailer not only introduced debit in its stores last year, but also created its own multi-functional terminal. This includes points-of-sale advertising, conducts customer surveys and processes credit card applications. They are innovating, as well.

Utilities, telephone companies and others have installed pre-authorized payment plans. Most of us have had the opportunity to visit major gasoline retailers who have installed debit and credit card reading devices directly at the pump. That is where you can pump and pay, and you still have to get out of your car. Soon they will have a way of doing it and pumping the gas remotely into your car, but right now, at least, you don't even have to leave the pump station to pay.

The observation I'm trying to suggest to you is that the consumer is becoming increasingly sophisticated, differentiated, and demanding in terms of payment method. How we pay and how consumers decide to pay depends on price, type of purchase, type of vendor, and interestingly, regional location.

I think you would find this extremely interesting. We don't have the time to go through the kind of survey material that is available. But one little interesting fact is that people embrace different types of electronic payment depending on where they are in the country. There really are regional differences.

Our challenge is to find innovative ways to meet the changing needs of consumers, the changing patterns of payment, and the continuing move from paper to electronic transactions.

I'd like to talk a little about how Interac fits into this future of payment innovation. I think it would be fair to do a bit of “back to the future,” because Interac's future began in November 1996. That was the date of the consent order. It was the culmination of joint efforts by Interac and the Competition Bureau to address perceived competition concerns within the current regulatory framework of the day.

The consent order really had an extraordinary result. It opened the network as much as was possible. The reason I say “as much as possible” is that any further broadening of the membership had to be addressed by Parliament and the legislative framework that governed access to the payment system. But as much as could be done within that system was done.

The order is very comprehensive. It altered the mandate and the governance of Interac. It prescribes the fee structure as well as membership. It also paves the way for new service innovations by smaller groups within the association, if that is the most cost-effective and efficient way of launching a new product.

• 2055

So it really was very forward-thinking, and I would suggest that it is still an excellent framework. It allows for innovation. And within the confines of a legislative framework in the Canadian payment system it opens the door as far as the members and consumers want.

In many ways I'd suggest that the consent order achieved the objectives laid out in the MacKay report, that networks be “operated in a manner designed to enhance competition in financial services and competitive equity among financial service providers.” The result has been growth and diversification in the membership and continued growth in the service.

As I informed you when we were last before this committee, the growth in the membership has been substantial. Since the consent order one of the most exciting aspects of this growth is the large number of smaller financial institutions joining the association. As a matter of fact, the last time I was here in September we had 61 members, and a month later we had 62 members. It continues to grow. These institutions are issuers; that is, they issue cards.

There's also been growth in the number of acquirers. These members provide access points, such as ATMs and debit terminals. This is an area where non-financial institutions are active, and include companies such as Global Payment Systems of Canada, SNS Systems Inc., CGI, and others. We forecast continued growth in membership, and it's happening as we speak.

With regard to Interac's future, as it continues, we foresee growth and innovation in the network in two areas: the expansion of existing services, and the development of new services. In both cases we see that the new direction for the future is not necessarily ATM-reliant or account-based. That's what is really very important.

What we mean is that we have to move beyond a paper-based, cheque-oriented payment system in order to meet consumer demand. The system is more and more telecommunications-based and Internet-based to provide its services.

Indeed, there is a growing number of ways to transfer funds to make payments. For example, a consumer can issue a standing order for monthly payment of bills and mortgages. This may be convenient for certain types of payments than manually depositing money into an ATM to facilitate that payment. There are all kinds of methods available.

In terms of existing services, there are many opportunities for growth. This will take place by expansion of services into new locations, both with debit terminals at the point of sale and with new ATMs. We closely monitor consumer trends. We do significant research into consumer trends and preferences to anticipate consumer needs.

There have been a number of innovations just in the past year alone to expand the points of access, such as through the use of wireless technologies to bring the terminal to your table, to taxis and to home deliveries of pizza.

To give you a sense of the growth potential, restaurant meals represent 19% of all consumer transactions, and this is a relatively new service for Interac. You don't generally have access to Interac service at restaurants. That is changing. With new wireless technology, we expect it to change even further.

ATM growth continues as well. In the past year the number of ATMs grew by 11%. New deployers are establishing themselves in banking machine operations as a standalone business. New people who weren't in that business are coming in and setting up those businesses.

Under the consent order they are entitled to levy surcharge fees for the use of their machines. They are taking bank machines to new locations, they are putting up the capital investment to do that, and they're offering more access to the system. That's what competition is all about, and that's what the consent order permitted.

As I said, another source of growth is new membership. One growth area is non-financial institutions; they continue to grow actively. Our market research, which I was referring to before, has also revealed areas where we need to evaluate what we see as lower levels of usage than the national average.

Surprisingly, the lower levels of usage are in large urban centres, such as Toronto, Montreal, and Vancouver. We have larger per-capita usage in other areas regionally. It's one of the issues we're looking at and one of the trends we're following.

• 2100

Under new services, the next generation of card payments will have computer chips embedded in them, replacing the magnetic strip of today. Two years ago we anticipated this development in Canada and we launched a standard-setting process for chip technology. This was a collaborative effort involving Visa Canada, Mastercard, and Mondex. We followed international standards for chip card technology to achieve interoperability within Canada. It will also allow international interoperability, allowing cards issued in other countries to be used in Canada and Canadian-issued cards to be used abroad. Following an extensive consultation process with retailers, government officials, and consumers, we have developed a common set of standards for chip, if and when any of us migrate to that technology.

One of the exciting opportunities presented by chip cards is the increased functionality: a single card that could have multiple applications on it, including debit, credit, stored value, as well as loyalty programs.

I want to go back to the consent order that governs us. The consent order envisaged the development of new shared services as well. It specifically allowed for development either among the full membership of the Interac Association or in smaller groups of the membership.

One area the board of directors of the Interac Association has identified for possible expansion since the consent order is new shared services, including balance inquiries, transfers between linked accounts, and deposits in ATMs other than your home institution ATM. You'll recognize this in one of the recommendations. A key consideration is how to achieve this. We want to be sure new shared services capture the realities of tomorrow's technology and tomorrow's consumer demands.

The Interac Association's vision for the future is absolutely full of challenge and opportunity, both in expanding existing services and reaching out to consumers in new and innovative ways. But it is important—and we're really delighted to have the opportunity to talk about that here today—to keep in mind that in a diverse and widely held system, new innovations are costly and complex. Business cases are required to address the issue of adding new functions to what may quickly become antiquated processes. That's the major challenge, I'd suggest, that what you build today may not be what you would build tomorrow. So when you invest for today, you have to be thinking about the operability for tomorrow and making some far-reaching choices.

Let me address the three specific recommendations in the task force report that impact directly on Interac. I'll be quite quick here. These deal with access to the payment system, oversight of payments networks, and activities undertaken by Interac. The challenge underlying these recommendations is how— What are they really talking about? They are talking about how best to broaden access by consumers to their funds. That's the purpose. The recommendations in the MacKay report offer some solutions.

In regard to task force recommendation 13, Interac contemplated the possibility of legislative change in this area when it negotiated the consent order. As I've indicated to you, everything that could be done was done within the legislative framework. If the government adopts this recommendation, amendments to the consent order would be required. The association is ready to expeditiously review and consider actions required to adjust its bylaws and we don't see that as a barrier.

With regard to task force recommendation 60 and the oversight of networks, here it is very clear to us that the consent order already governs the activities noted in this recommendation. It is very far-reaching. It governs competition policy issues. It governs the operations of the network as well as access. It governs things like membership.

• 2105

We are anxious to work with the Minister of Finance, this committee and others so any changes to the regulatory framework do not create duplication or inefficiencies. An enormous amount of effort and time was put into the negotiation of the consent order that permits the kind of access Mr. MacKay is referring to in his report. It stands there, and we would certainly want to make the point that duplication would be inefficient.

Finally, on task force recommendation 17, we recognize the potential benefit to consumers of added services. The association has been actively pursuing the possibility of adding functions to the network. They continue to do that.

We do not disagree at all with the constant need for innovation. Indeed, that's our future bloodline. This constant need for innovation feeds the association. We actively support and encourage it. However, it is our view that the experts who devise and develop technology solutions are in the best position to determine how to implement innovative solutions to consumer needs.

The solution in recommendation 17 is one way of addressing service to consumers, but I think this committee needs to be aware it is a costly and complex solution. It is not a simple flick of a switch that would allow it to happen. It's also important to recognize that all these innovations are happening within the context of a Y2K issue and the work and investment that has to be made in that context.

Before members invest in technology to facilitate these kinds of added service, they want to be sure it is the best way to meet the needs of consumers today and tomorrow. As we mentioned, with a significantly enlarged membership of diverse participants—some large and some small, some ATM-based, some more interested in the growth technologies—whatever solution is found needs to be evaluated carefully. We are doing that seriously. We are actively looking at those solutions with a common goal of finding more opportunities for serving the customer. That's what the business is all about.

We want to do it in a forward-looking way and we do not want to base our innovation on past solutions. We want innovation to be based on the future.

I hope we've addressed some of the issues before you today. Either my colleague or I would be delighted to answer any questions.

The Acting Chair (Ms. Carolyn Bennett): Thank you very much.

[Translation]

Mr. Desrochers.

Mr. Odina Desrochers: I must say that I am somewhat disappointed that the documents are only in English. I trust that you know that there are many people in Quebec who make use of your services.

Now, I have several questions to ask you. I have a vague impression that you have done very well in promoting your services, but that you have failed to say how much they cost.

First of all, why did the Bureau of Competition Policy feel the need to intervene to help you broaden your membership? Could you have done so before, without the intervention of the Bureau of Competition Policy?

[English]

Ms. Judith Wolfson: On the response, Mr. Desrochers—and my colleagues who were there at the time, Mr. Lacombe and Mr. Harris, can assist me—there was a perception, as I indicated, that the membership was too closely held and there was not sufficient access for other participants. There were lengthy discussions and it was a consent order as opposed to an imposition. It did not go to the tribunal because there was an understanding that there could be a system where many others could participate, and indeed have. It's an open system to both issuers and acquirers—direct connectors and indirect connectors—according to their business needs.

This was an evolution that was happening. There was a very short period between the time it started and the time we have. That's the best understanding I have of that.

[Translation]

Mr. Odina Desrochers: Now, even though your membership has increased, have the rates been adjusted accordingly, given that there are more Interac members?

• 2110

Then, there was talk of an agreement signed recently. At the moment, when I go to a Royal Bank Interac ATM with my Desjardins bank card, it costs me $1.25 to pay one of the two institutions; there are no plans to invoice charges to pay the two institutions. That being the case, will you be able to maintain your current rates for consumers?

Mr. Marc-André Lacombe (Corporate Secretary and Legal Counsel, Interac Association): We have studied this question. Interac never charges the user. When you use your Desjardins card at a Royal Bank or Bank of Montreal ATM, it is Desjardins who charges you an Interac fee. There are no Interac fees for consumers. Our expenses are paid by our members. Our members pay charges for each transaction to offset the cost of operating the system.

The Bureau of Competition Policy and the Competition Act prohibit our members from discussing these charges. The Bank of Montreal decides how much it costs the bank and determines what charges I must pay when I use my card.

Mr. Odina Desrochers: At the moment, we pay only one institution when we go to an ATM other than our home institution ATM, but I have been told that I may have to pay additional costs, both to the institution whose ATM I am using and the institution from which I am making the withdrawal. Is that correct?

Mr. Marc-André Lacombe: Yes it is.

Mr. Odina Desrochers: Will there be other cost increases, given that there will henceforth be two institutions to serve? I know that we don't pay Interac, that these are simply charges, but I am attempting to defend consumers.

Mr. Marc-André Lacombe: It is one of the things that was covered in the consent order with the Bureau of Competition Policy. They were emphatic that we had to stop prohibiting members from charging for the use of their ATM machines.

Currently, members are entitled to assess additional charges when you use their ATM. This is what made it possible for new members to place ATMs in locations where it would not otherwise have been profitable to do so.

Interac ensures that consumers are informed. When you go to an ATM, if the institution or member providing the service wishes to assess additional charges, customers must be notified in advance, and given the option of continuing or stopping the transaction.

Mr. Odina Desrochers: With respect to recommendation 17, the MacKay Report now says that— Here is another example. I have a cheque signed by the Caisse populaire Desjardins and I could go and deposit it at the Bank of Montreal. Before MacKay makes this recommendation, is offering this service something you have considered?

[English]

Ms. Judith Wolfson: There is an opportunity, and we are looking at exactly how to offer that service, where we can look at its functionalities, not just shared deposits but also other opportunities, and add functions.

We have no difficulty with the recommendation that there be added functions. It's how you do them, and they shouldn't necessarily be paper-based. I think that's really what our concern is. This recommendation seems to imply you use the same system of paper. It's extremely expensive and inefficient to have paper put into a cheque deposited in an ATM in one part of the country, opened up for security reasons and fraud reasons by two people, and transferred across the country in order to get a deposit in your account in another bank in another part of the country.

The shared deposit isn't the issue; it's how to do it, and we want to find good technological solutions to doing it. It doesn't necessarily have to be paper-based. If we look at the statistics on how cheques are going down in usage, to find a business solution for cheques does not necessarily meet the test of what consumers will want, in our view.

It is a recommendation for the way the system may be working today less and less, but not for tomorrow. We want to look at added functionality but not necessarily in the way the task force might be envisaging. Indeed, they didn't necessarily have that expertise of the specific technologies before them.

• 2115

[Translation]

Mr. Odina Desrochers: You have just made a long statement about the future, but what I asked you was whether you had considered it before MacKay spoke about it. Yes or no?

[English]

Mr. Judith Wolfson: Yes.

[Translation]

Mr. Odina Desrochers: Thank you.

The paper I saw was heavy on promotion. I am wondering whether you are there to serve consumers or to serve the interests of your members. There is much discussion of membership, but not much about the consumer, in your document.

[English]

Ms. Judith Wolfson: In our response we tried to convey that this is absolutely consumer-driven, and our members are constantly dealing with their consumers. It is our members who have all the clients as issuers and acquirers, and they are constantly looking to serve the consumer in a competitive environment. I would certainly hope our presentation indicates we follow consumer trends actively. We assess them and do research continuously to see where consumers are going, and wish to go, in electronic payment.

[Translation]

Mr. Odina Desrochers: There is discussion of smart cards and new charges that may be authorized, fees to be paid to the institution from which a withdrawal is made and to my bank. Can we expect a scenario like some we are seeing now, in which GM becomes associated with Visa or another company? Could Interac authorize certain services with overall charges between institutions, between banks, or do you intend to maintain services on the basis of each individual member?

Mr. Marc-André Lacombe: I am not sure I understand the question, even in French.

Mr. Odina Desrochers: I will speak more slowly.

Mr. Marc-André Lacombe: It's not because of the speed.

Mr. Odina Desrochers: I am still speaking from the point of view of the consumer, and I tell myself that at some point, the consumer will pay. Could certain institutions not therefore be at some point get together with certain businesses to establish a more general fee?

For example, we now pay $1.25, $1.25, $1.25 and $1.25. If the institutions could come to an agreement, we might be able to pay a total of $2.50 for these transactions, instead of a larger number of individual charges.

Mr. Marc-André Lacombe: User charges for Interac services are set by members independently. The Competition Act prohibits us from setting these charges. Charges for a direct Interac payment vary enormously. Each institution has package arrangements or establishes charges per transaction. Interac has nothing to say about these. The Competition Act prohibits us from speaking about it. Of course, when smart cards are introduced, the Competition Act rules will apply, and the members will not be able to decide what these charges are.

Mr. Odina Desrochers: Thank you. Even though I had some minor but somewhat sensitive questions to ask you, I must say that I am well served by Interac and very satisfied with the services you provide me.

Thank you Madam Chair.

[English]

The Acting Chair (Ms. Carolyn Bennett): I have a question. The role Interac will play in any sort of decrease in bricks and mortar is important, and whether that's with or without mergers, our colleagues are certainly worried.

Your comment in terms of the cheques and what consumers may or may not want worried me a little bit, because if we shoot beyond what consumers need right now in terms of a business case, a lot of consumers will not be served as the branches close. They won't be able to make deposits because there won't be the hardware near them that is in the same family as that of the bank or credit union or whatever it is they usually deal with. Particularly, the Hongkong Bank was concerned that this would greatly enhance their ability to do business.

• 2120

You said why this hasn't happened before, that it's a very complicated procedure in terms of the paper, but MacKay has been clear that this would be a good idea. Do you feel you will be able to deliver deposits in any sort of machine in terms of the consumers being able to do this, and in terms of this obvious transition with decreasing bricks and mortar?

Ms. Judith Wolfson: There's no question that we're certainly looking at it. As I said, it is quite complex and difficult to implement easily the issue of shared deposits, but we are certainly looking at ways of doing it and transitioning.

If I can address the first part of your question, though, we referred to it a little bit when we talked about regional differences. What is quite interesting is that we have more of an uptake in less urban areas.

The Acting Chair (Ms. Carolyn Bennett): That's not surprising to me at all, because I go to my bank machine to get cash, and if there's not a bank machine near me and the bank's closed, then I'll use my Interac.

Ms. Judith Wolfson: And there are more people. Exactly.

The Acting Chair (Ms. Carolyn Bennett): the availability of machines in Toronto allows you to have your old habits. If there isn't a machine and there isn't cash, then people use the card, right?

Ms. Judith Wolfson: That's exactly right. Therefore, in the transition, we have to look at whether or not there are ways of assisting them. Firstly, are there different regional answers, potential regional solutions for this issue of added functionality of shared deposits, etc.? Also, are there interim steps? To put in a system that has the infrastructure required to do this is significant, and it's significant for a period of time when cheques are becoming less and less used.

The problem, of course, is the pricing. The less the activity, the higher the cost—and I don't mean necessarily so much for the institution as for the consumer. If you're going to have a service or a function that becomes prohibitively expensive as well because of the lack of economies of scale, you also have difficulty. These are the issues that we are actively looking at, and the board of Interac has requested that we look at options for solutions.

The Acting Chair (Ms. Carolyn Bennett): We have huge concerns for small business about where people bank. Particularly in the rural areas, in the small towns, people go to do their banking somewhere else and then they do their shopping there.

We're not only talking about cheques, we're talking about cash. A small businessman in a very small town wants to be able to deposit his till at the end of the day in a place that's convenient. There might be a charge for that, but it sure beats getting in a car and driving an hour each way, which is what a lot of small businesses are describing to us right now.

So I guess I want to ask where the place for the business case is in terms of whether or not your board thinks it would be a good idea. As policy-makers, where do we have to say there is a service imperative of looking after these small communities? For the same reason they've closed the branch, it may mean the machine isn't quite as well used.

Mr. Fred Harris (Senior Vice-President, Service Delivery, Interac Association): Maybe I can answer this.

I guess there two things there. In the past, we've looked at shared deposits as taking a cheque and expanding that to the network itself. You mentioned cheques as well as coins or cash. You can't put coins into banking machines.

As far as retailers—

• 2125

The Acting Chair (Ms. Carolyn Bennett): Wait a second, I thought we were looking to the future. Why can't you put the thing in with everything in it, seal it and put it in the machine?

Mr. Fred Harris: I don't know of a machine—

The Acting Chair (Ms. Carolyn Bennett): If my dad's taking off the till of his flower shop every night, why can't he just put all the cash in an envelope and put it in the machine?

Mr. Fred Harris: Let me just finish what I was trying to say.

Immediately, I think there are some solutions. One is the fact that retailers are using direct payment to put cash back into the consumer's hands with a service called cashback. You go in, make a purchase for $40, debit your account for $80, and the retailer gives you $40. That's one avenue the retailer can use in order to not have to take the cash back to the bank.

When we look at this task force report, it addresses an issue of how to get money into these accounts. We believe it then steps right to one of the solutions. We think what we need to do is look at—and I think Judith has said this—whether or not there are many more solutions. We know the number of cheques used is going down dramatically. You've seen one of our pages that indicates the cheques made out to retailers over the last four years. Our surveys have indicated that we've gone down to 5% from 12%, so the number of cheques is reducing.

We're concerned about changing the systems to allow for more paper handling, where the cost of that will just escalate. What we're trying to do now is look at that in order to look for a broader solution. Is there a much better solution? That's something you've just talked about. Is there a solution out there whereby you can just take something—you've described it as a large envelope—with everything in it? Maybe the message is that it's not a bank machine.

The Acting Chair (Ms. Carolyn Bennett): I think you have explained why the deposits haven't been done up until now. Is that—

Mr. Fred Harris: If I can use the example of putting a deposit in one of these machines, I have a bank card that connects me to my account and I have a cheque. You could write me a cheque, but I'm in Halifax and your bank is in Vancouver. I can stick that cheque in a banking machine on the east coast, and the money electronically goes into my account. That's what happens today. But the institution that takes the cheque doesn't know that the cheque is valid. The cheque could be for the wrong amount, or there may not be any funds in your account out in Vancouver. It has to get there. Because of the clearing system that we have today, that cheque gets there very quickly, overnight in most cases.

If you start to expand the chain of where that cheque has to travel, it could take three to four days before it gets to your account in Vancouver. If I already have the money in my account, then you get the issue of how you are going to unwind that transaction. One side's electronic and one side's paper. I think that's part of the problem.

The Acting Chair (Ms. Carolyn Bennett): I recognize that, but I also feel there are a lot of small towns and a lot of people who have less and less choice. You're now the only game in town, and you may develop a business case that says it's not a good thing to take deposits from other banks because you think the puck's going here and you don't want to be stuck somewhere else with your stick on the ice. I'm wondering what's in the public interest if you decide there is no business case to take deposits in dissimilar family businesses.

Ms. Judith Wolfson: I don't think we should assume that not taking deposits is the same as not having a cheque-based deposit system. What we are looking at is what the options to help take deposits are. Is there an Internet-based system? Is there a telecommunications-based system? Can we do it that way? The issue is whether it has to be be paper-based. The recommendation only looked at one option. Our response would be that we do need to look at added functionality and we do need to look at what the consumer needs, but I don't think we should presuppose the answer. I think the recommendation presupposes a paper-based cheque deposit system, as opposed to looking at the issue that we're trying to address and what the options are. That's what we're trying to do.

• 2130

The Acting Chair (Ms. Carolyn Bennett): My concern would be that the recommendation at least presupposes a transition period during which people will have to get used to the idea of looking towards another system. In the meantime, they have cheques, they have deposits to make, and they have hugely complicated lives in trying to go about doing that. I worry that you could just decline to do that, because you are the only game in town.

Ms. Judith Wolfson: Firstly, I just want to be quite clear: we, the Interac Association, aren't the ones who manage these. These are all proprietary systems owned by the members. We don't make those decisions as an association. We don't decide how many machines will be in any particular location or how those decisions are made. Those are made by the members as part of their own business. Certainly, what we do is work with all those members to facilitate those systems.

These are issues that are of extreme importance to consumers. I agree with you. I think what we have to do as an association is offer options. I know the association takes that very seriously, and it is looking very seriously at how to meet those consumer demands. Right now, there isn't a paper-based system in place to do that, so the interim solution is not easily found. It's not like we're taking something that's in place and cutting it off to try to do something else. It has to be invested in and developed.

In the development, what we want to do—and we are here to suggest this to the committee—is ensure that there be at least a broad-ranging look at the options to meet those consumer demands, as opposed to creating a new system that may not be the most cost-effective or efficient. That's really the position we're putting forward.

The Acting Chair (Ms. Carolyn Bennett): I guess I would like some assurance on this. If a town loses the only bank it has and now only has a machine, what should we be doing as parliamentarians to try to convince people that this machine should take deposits?

Ms. Judith Wolfson: The machine does take deposits to its own institution, of course. It's shared deposits that we're talking about. Obviously, if there are fewer options, that becomes more difficult.

Right now, we have not seen consumer demand or member demand that is broad-ranging. We have had a number of smaller institutions—it's not consumers raising this issue, but smaller institutions—that are looking to increase their market through other systems by other issuers and acquirers. To date, that issue certainly has not been brought forward as a major concern. It has been brought forward by a few of the smaller institutions that would like to catapult onto a bigger system.

The Acting Chair (Ms. Carolyn Bennett): I'm just saying that as the bricks and mortar are reduced, this is a salve that could be offered up should banks make those decisions.

• 2135

What about stamps and things? When you talk about increasing the functionality, what else do you think you could be doing with those machines? CIBC is selling stamps.

Mr. Fred Harris: Members are free to do anything in these machines. Basically, Interac lays down some rules to say that when you make the final payment for the goods, it has to fall within these rules. But it's the members themselves who are the people building the machines that will dispense stamps or will dispense tickets. There aren't any limitations on that. It just depends on whether or not someone wants to do it.

The Acting Chair (Ms. Carolyn Bennett): Great.

Well, thank you very much, and I'm sure we'll see you again.

We'll move right along to the Council of Canadians.

Mr. Peter Bleyer (Executive Director, Council of Canadians): Thank you.

My name is Peter Bleyer. I'm executive director of the Council of Canadians. My colleague here with me tonight is Jamie Dunn, who has been working on this issue.

We'd particularly like to thank the committee for meeting with us at this hour. We find it refreshing to be on Parliament Hill this close to ten o'clock at night. We're sure you've been doing it on a regular basis, so we'd like to congratulate you for the seriousness with which you pursue this work.

[Translation]

I would like to begin by apologizing, particularly to Mr. Desrochers, for having only an English copy of our presentation for the moment. We will have the translation sent to you as soon as possible. We can of course speak with you in French if required. We will nevertheless try to be brief.

• 2140

[English]

First, I want to put on the record once again what the Council of Canadians is. We're a non-profit public interest group. We currently have more than 100,000 members from coast to coast. We were founded in 1985 with a mandate to work to safeguard and promote Canadian sovereignty and democratic development, as well as to work for social and economic justice. So again we probably are coming to this table with a rather different perspective and background from some of the specific special interests you've heard from. That's not to denigrate them; we generally speaking get denigrated as special interest, so we wouldn't want to do that to anyone else.

The first question to answer is why would the Council of Canadians and our members be interested in this issue? It's our view that the future shape of Canada's financial services sector will have a dramatic impact on all aspects of our organization's mandate and mission, which I've just described to you. Our members, literally thousands of them, have sent us a clear message that they are concerned that both further deregulation, which we see as being unfortunately the overwhelming message coming out of the task force report, and the proposed bank mergers present a serious threat to our capacity as Canadians to determine our social and economic future.

I want to briefly speak in very general terms to the content of the task force report, because I think that's the mandate of this committee. We might have preferred to see an all-party committee that was dealing specifically with the bank mergers, because we think that although we know it's also included— We will speak to that as well.

What we view as being right with the report is, first of all, its recognition that the status quo is not sustainable and not acceptable. In terms of the financial services sector there are changes that must be made. We also think that the task force has made a series of what are interesting recommendations to protect consumers in what is increasingly the jungle of the financial services sector. We won't get into the details of those recommendations. You've heard from a number of consumer groups, I think, in the last number of days on that specifically. We'd like, unfortunately, to emphasize what we view is wrong with the report. From our perspective, coming from the mandate and mission we have, there is a lot wrong.

The positive contributions included in the report that I've noted are overwhelmed by what is really a complete failure to consider the reality of the global situation we face today. When it comes to this big picture, the report is really wildly out of step with that reality. At a time when the results of massive deregulation and foreign investment are coming home to roost from Rio to Moscow to Tokyo, and to many points in between, the task force is in effect recommending more of this very same prescription for Canada's financial services sector. In fact, the situation we face today in Canada is already the result of more than a decade of deregulation in the sector, and the task force is proposing more of this disease as the cure.

I want to identify one major problem that we see in the task force report's recommendations, and it has to do with the issue of foreign ownership. We would have preferred to see the task force focus on recommendations that would not further undermine, in fact would re-stabilize and maintain, the stability of the financial services sector and its ability to best meet what we view as the real needs of Canadians and their communities. And that would have included a clear statement from the task force regarding the mergers—let's say, a red light rather than the yellow light that some have referred to on the bank mergers.

Rather than doing that, the task force proposes measures such as the entry of foreign banks as a remedy. Frankly, the notion that we're likely to be able to make foreign banks meet the needs of Canadians when we fail to do so with our own banks is difficult to swallow, if not laughable.

To go over a few of the problems with increased foreign ownership, first of all, increased foreign ownership is once again being proposed as a remedy to increase competition. It's clear that when it comes to foreign entries, foreign banks will head for profitable niches. They're not going to head for the hard-to-reach low-profit corners of the retail sectors. They'll be skimming off profitable large urban centres, catering to the more lucrative commercial and corporate clients. This you no doubt have heard from others as well.

• 2145

Given the high cost of starting up as a full-service bank, assuming that any of these foreign banks would ever want to do this, it's a lot easier to just buy up one of the existing full-service Canadian banks, which we would argue is not in the best interest of Canadians and their communities.

We would also identify the fact that allowing foreign-owned deposit-taking institutions to operate in Canada could very well entail, and we think does entail, some serious prudential risks for Canadians. For example, will depositors be covered by Canada's deposit insurance? I think you've heard from CDIC earlier today. I don't know what you've heard, but in any case, that's one of the issues we had raised. What safeguards would there be in the event of a foreign bank failure with regard to Canadian depositors?

Similarly, Canadian activities will inevitably remain secondary for any foreign-owned bank. In the case of an economic downturn at home or some other business or market failure, assets held in Canada will be rapidly shifted homeward—in effect, instantly exporting to Canada economic difficulties from away.

Most importantly—and this is somewhat to repeat something I have already said, but I think it bears repeating—those who see greater foreign competition as the magic bullet to lessen the impact of the proposed mergers are making a serious mistake. Allowing foreign banks greater access would actually require more deregulation of the financial services sector, which in fact is the overall tune of the MacKay task force report.

But again, as I said, more deregulation actually means more concentration, not more choice for consumers. If you need evidence, just look at the current situation in Canada. We've been through deregulation; we've been through changes to the Bank Act over the last number of years, particularly under the Mulroney government, and those changes have led to increased concentration and less choice for consumers.

There's plenty more evidence, but as far as we're concerned, you could stop right there.

I want to speak for a moment to the question of the mergers. Again, you have heard numerous arguments against the proposed mergers. The arguments are clear. They're actually growing more numerous and in fact more powerful. The statements made by Governor Thiessen a couple of days ago are a case in point.

First of all, the mergers are not necessary, since studies show quite clearly that Canada's major banks have already achieved the size necessary to achieve the kinds of economies of scale that could be useful in the banking sector. Moving beyond that is not necessary.

The mergers are not helpful because, again, the empirical evidence doesn't support the contention that mergers will increase efficiency and reduce cost to consumers, nor will the mergers improve access to service. A lot of the discussion in the MacKay task force report, which I'm sure you are having, including the discussion with our friends from Interac, was about how we limit the potential damage as we lose bricks and mortar, and so forth. The mergers are about, in effect, limiting service—for example, to rural communities.

Regarding access to loans for small businesses, if we have one wicket instead of two in a particular community, how does that help the small business person looking for capital? Obviously, it does not. We would have to find band-aids to correct the damage that a bank merger would create.

Finally, the point we would dwell on is that the proposed mergers are actually downright dangerous for Canada and for Canadians. There is, first of all, the ominous nature of the potential failure of a megabank, which again was drawn out by Governor Thiessen, or at least the reporting of what Governor Thiessen said. I think it's important to dwell on this question of how potentially dangerous the mergers are for Canada and for Canadians, and I think the word that comes to mind more than any other here is “democracy”.

The extent of concentration in our banking industry and in fact in the broader financial services sectors—because we're talking about both vertical and horizontal integration and concentration, actually, and the recommendations in the task force report with regard to insurance and banks moving into that area, and so forth, speak to that point—has long been a concern, not only because it increases market power held or the ability to control prices, but also because it may lead to the exercise of undue political power by these corporations.

• 2150

Larger banks, as with other large corporations—but we think the banking industry is a case in point—can use their vast economic clout to influence public policy and undermine the ability of governments to govern in the public interest.

Over the months since the dramatic announcement of the first proposed merger between the Royal Bank and the Bank of Montreal, we've seen numerous analysts raise the spectre of the kind of crisis or economic impact that might ensue from a rejection of this proposal. This has already come to the fore, even in a pre-merger situation.

Again, Governor Thiessen's comments are kind of instructive here when he speaks about the implied threat of the failure of a megabank. And of course I would be remiss if I didn't refer to the thinly veiled threats of unnamed CEOs of various banks, banks that would like to merge, in terms of what Canadians will suffer if they don't accept these mergers. What will we be subjected to from Messrs. Barrett, Cleghorn, and others if we do allow them to merge and increase, as we think, their economic power and clout, and consequently their political clout? Frankly, economic power is a key ingredient behind political power.

Just to finish off, we do in our brief make some recommendations. We think the MacKay report's recommendations to protect Canadian consumers need to be accompanied by a comprehensive renewal of regulation for the financial services sector. That would include a reaffirmation of the ban on big buying big, a continuing commitment to opposing foreign ownership in the sector, and proposals such as a new national investment fund funded through a tax. There are a number of ways of doing this, but one in particular is a tax on above-average profits, for example of banks, which would be used to promote economic development, community economic development, and job creation.

We'd also like to mention that any renewal of the regulatory infrastructure and framework has to include proposals to deal with the destabilizing flows of speculative capital across international frontiers. Finance Minister Martin's statements in Washington and elsewhere leaning in this direction are heartening; although we're wondering, if we're talking about regulation at a global level, where's the national regulation that global regulation would be built on?

In this context, it was also encouraging to hear that the parliamentary secretary, who I think was here earlier, yesterday or very recently actually endorsed the Tobin tax or a tax on financial transactions to the minister and is looking at that as a possibility.

The Chairman: For the record, I don't know where you got that from or what channel you were tuned into, but I don't think Mr. Valeri has ever endorsed the Tobin tax.

Mr. Peter Bleyer: It's something in Hansard.

The Chairman: I may be mistaken, but—

Mr. Peter Bleyer: I know that— maybe it was at the blues stage that I got it and he didn't have a chance to change his mind before I saw it. I have no idea.

The Chairman: I don't think so.

Mr. Peter Bleyer: We'll follow up the matter. I'm sure you will as well with Mr. Valeri.

The Chairman: Thank you. I would appreciate that.

Mr. Peter Bleyer: Absolutely.

In any case, we were heartened, and maybe I'm a little less heartened to think that it may not be true.

But certainly we agree there are new global realities out there, and any attempt to do something, for Canada to play a leadership role— We have to take care of the situation at home. We also have to play a leadership role in terms of managing the kind of speculation on a global level that's a threat to our ability as a nation to ensure our citizens' social and economic future.

On that note, may I say we're obviously happy to entertain questions. I'm just thinking of my three-month-old at home, but I'm sure others have children. I know there's a seven-week-old in the House of Commons, so obviously I shouldn't be complaining.

Thank you. We welcome questions from members of the committee.

The Chairman: But your presentation is really about securing the future for future generations.

Mr. Peter Bleyer: Exactly. Absolutely.

The Chairman: I hope that makes you feel a little bit better.

Mr. Peter Bleyer: Absolutely.

The Chairman: Thank you very much for your presentation.

[Translation]

Mr. Desrochers.

Mr. Odina Desrochers: Thank you Mr. Bleyer. We will certainly take the time to hear you, even if it is 9:55 p.m. The Finance Committee agenda is very full, which is only to be expected given that it is considering two important matters at this time: the pre- budget submissions and the MacKay Report, which are closely related. That is why we are sitting a little later than usual.

• 2155

You spoke of protecting bank and financial markets in Canada. Did you know that 40 percent of Canadian bank business is now carried out outside the country? How can we encourage our banks to do business abroad by closing our borders to other banks which would like to offer their services and perhaps even be of greater help to consumers? I would like your opinion on this.

Mr. Peter Bleyer: Firstly, for us, the primary goal is not to encourage our banks to do foreign business. We recognize the reality of international links. We know that there is international commerce in terms of financial services, but for us, the banks, although they are private companies, are like utilities. That is what their functions amount to. So for us, the most important thing is not to encourage banks to go and make loans in Latin America, etc., but to ensure that the banks provide appropriate services to Canadian consumers, reinvest the money and do whatever is necessary for security at more of a macro level. That is the level at which banks must do their work in Canada in our view. For us, this it more important.

We are not here to tell the banks to increase their foreign business. We believe that if they need protection in the domestic market, we must ask them to make certain contributions to Canadian society.

Mr. Odina Desrochers: How does the Council of Canadians see the globalization of markets? Are you free traders or do you tend more towards a stricter, more closed nationalisms in Canada?

Mr. Peter Bleyer: We believe that the work of politicians and governments at all levels is to protect the interest of citizens. If, in order to protect the best interests of citizens, limits have to be set limits on foreign transactions, then that is what politicians must do. Their work is not to ensure that the banks, in particular, do more business.

It is not a matter of being against globalization. Allow me to compare the position of the Council of Canadians to the MacKay Report's perspective. The MacKay Report does not give proper regard to the reality of globalization, which has led the world to the brink of an economic crisis. We are aware of the impact of globalization and want governments to react in a way that will protect our communities.

Mr. Odina Desrochers: That was a small yes that just made it through your lips; you do not appear to be very enthusiastic about market globalization.

Mr. Peter Bleyer: Absolutely not. How could one be at this time? Getting enthused about the globalization of markets in the fall of 1998— I don't think so—

Mr. Odina Desrochers: We don't have the choice, Mr. Bleyer; negotiating with the WTO is not optional. We have operated under bilateral agreements and now we need multilateral agreements.

I am not an official defender of the MacKay Report, but I must say that as a discussion paper, it forces us to ask serious questions about the reorganization of financial services. It is not just a question of bank mergers.

You appear to be afraid of a catastrophe, of megabank failures. If I asked you to tell me what the positive aspects of the reorganization of financial services are, what would you say?

• 2200

Mr. Peter Bleyer: I would say that we have to reverse the process of deregulation begun by the Mulroney government in the 1980s, which will continue unless some of the recommendations of the MacKay Report are implemented. For us, first of all, it is necessary to reverse that process and restore

[English]

the reserve requirement.

[Translation]

If you can't translate for me, someone else will.

Some measures implemented in the past were excellent, but did not go far enough. Thus, increased regulation in this sector is necessary, regulation that pays more attention to communities. It would be not only national regulation, but also regulation that gave due regard to Canada's communities. Such regulation would review the actions of banks and other institutions in the sector to ensure that they are in the best interests of these communities. This is a relatively simple message, but it must start with a reversal of the process that was begun 10 or 15 years ago.

Mr. Odina Desrochers: I have one final question concerning this process. In terms of market globalization, do you not have the impression that you will be penalizing our country by acting in this way? Do you not think that a more avant-garde and pro-active approach is necessary?

Mr. Peter Bleyer: Let us look at Russia, for example. Russia was avant-garde. Where is it today? The economic crisis pales compared to the social crisis, the crisis of society that is being experienced generally throughout Russia.

Mr. Odina Desrochers: Frankly, sir, one cannot compare Canada and Russia.

Mr. Peter Bleyer: Being avant-garde—

Mr. Odina Desrochers: We never had a socialist system. In Russia, there was a shift from socialism to capitalism. You can't make such comparisons.

Mr. Peter Bleyer: You asked me if we should be avant-garde. We need to define what we are talking about. Should we be avant-garde as a matter of principle? No, absolutely not. Should we be avant- garde in a way that helps us achieve objectives such as meeting the needs of Canadian communities? Yes, absolutely. There must be absolutely no question of an arbitrary avant-gardism. We are against that.

In the MacKay Report, there is discussion of free market ideology and deregulation as if the developments of recent months and years had never happened. What we are seeing is rather an indiscriminate avant-gardism. I agree with you that the MacKay Report raises important and interesting points. We are not saying otherwise, but the major point that comes out of that report is that it agrees to continue along the existing path in spite of what is going on in the world, and in spite of what it might bring to Canada.

Mr. Odina Desrochers: Thank you, Mr. Chairman.

The Chairman: Thank you Mr. Desrochers.

[English]

I would like to go back, Mr. Bleyer, to a theme you introduced about your three-month-old son. I really want to speak to that, because really it's what this exercise is about: it's about building a future financial services sector. And if there's been an element of disappointment on my part, it has been that many people appear in front of this committee basically talking about the present and/or exercising a great deal of what I refer to as “turf protection” of their industry, etc., which to me is not really where it's at, quite frankly. I think that as a country we need to grow up and start painting our future, having a clear vision. I may or may not agree with your vision of the future, but I think in many ways you have attempted to define what you perceive to be the future by excluding certain issues, such as, for example, the issue of bank mergers. You feel they would create corporate concentration. You also went on to say that if these mergers happen, it's proof positive of the fact that banks have political clout. That's what you said, right?

• 2205

Mr. Peter Bleyer: It would be another indication. I think—

The Chairman: So I gather if the government says no to them, you don't think they have it.

Mr. Peter Bleyer: It's an important point. We're happy the matter is getting consideration, on the one hand, but in fact we're concerned that so much attention, including from us—we're putting a lot of emphasis on the bank mergers—is a distraction, and I think this goes to the point you're making, from the fundamental issue of how do we create the kind of financial services sector that our generation and future generations in this country need to thrive. The bank mergers are on the table as a result of a hijacking of a process by specific commercial interests, these four banks.

What we actually would prefer to see, and in fact the finance minister I think is the only person in a position to do this right now, is a clear message that says the bank mergers are off the table now. Now we can get down to the serious business of talking about how we re-regulate the financial services sector to meet the kinds of objectives you're talking about.

The problem we face now is a lot of us are focusing on bank mergers, as we need to because we see this bank merger as a severe threat. But it's also taking up a lot of your time and taking up a lot of the finance minister's time, and we prefer to see that time applied to the public interest agenda, whereas the bank mergers really are only the banks' agenda. They should not be on the table right now. I think it would help to get to where you want to go if this committee asked the finance minister very soon to actually say, look, the bank mergers are off the table, formally. They're off the table; we're not looking at these at all. They're not a possibility. We want to deal with the big questions and we'll leave the rest to—

The Chairman: As far as this committee is concerned, they're not off the table because they never were on the table—

Mr. Peter Bleyer: They may not formally be on the table, but if I pick up any one of Canada's more and more numerous national newspapers, which all seem to say more or less the same thing, they all seem to think it is on the table. The Canadian public thinks it's on the table. The banks' CEOs think it's on the table. In the reality of what's going on out there in this country, the bank mergers are the issue.

The Chairman: But you understand, though, that as far as this committee is concerned, we're not dealing with the two proposed mergers.

Mr. Peter Bleyer: I understand you're not directly dealing with them, but, you see—

The Chairman: We're dealing with mergers—

Mr. Peter Bleyer: —our contention is you can't deal with the MacKay task force report without dealing with the fact that the bank mergers have potentially hijacked the process.

The Chairman: As long as it's very clear in your mind that we're dealing with mergers as a legitimate business practice. It happens all the time; small companies merge. The two proposed mergers you're thinking about have captured the imagination of Canadians, reporters, and everybody else, but as far as this committee is concerned—

Mr. Peter Bleyer: You could solve that—

The Chairman: Let be me very clear that we're concerned about building a world-class financial services sector that allows also a vibrant domestic financial sector to evolve and also to address some of the key concerns. We've heard about enhancement of the payment system. We looked at a very extensive consumers' package.

What I really want from people is to sit down and look at the MacKay task force and say that, generally speaking, it's a balanced approach towards reform of the financial services sector and that the following points or recommendations should be seriously considered because they speak to our vision—I'm talking about yours now—of the 21st century financial services sector.

I'm going to go back to you—

Mr. Peter Bleyer: You want me to say that? Oh, you mean our vision—

The Chairman: Yes, your vision. I'm interested in yours. I have mine, you have yours, and maybe one day they'll meet together—

Mr. Jamie Dunn (Representative, Council of Canadians): I'd like to address that. I don't think you were here when I was introduced. My name is Jamie Dunn and I work for the Council of Canadians. There are two principles we'd like you to hear from us tonight, and one is that what this is about is not about government micro-managing business, or it's not about us saying we should come in and attack the nasty profit-makers. That's not what we're here to say.

• 2210

We're here to say there's a real threat happening now in the global community. It's representative of a reversal of what we consider to be the proper process of regulation, which is that you have to ensure the bottom line. You have to ensure that certain absolutes are met. You can't delegate those to what I would rhetorically call mystic forces. I think what we've seen in the report is an over-reliance and an overly positive attitude toward things like competition. There's also an overly positive attitude toward the force of the consumer in what I believe the report calls the force of discipline in the market.

We think issues like the disciplines in the market should be brought forward by the collective voice of citizens in this country, not by isolated consumers who have jobs, as Peter mentioned, and dogs that are sick and everything else, and then have to go out but don't have the expertise—this is the majority of people—the time, or the resources to sort through the many and very complicated vehicles and products out there in the financial services community.

We think the job of government is to listen to what people are saying are the bottom lines. These are the services people need to have, regardless if these are from banks or any other of the institutions. These are the services that can't slip through the cracks.

We're saying that 400,000 Canadians cannot be excluded from the banking sector. We're not saying to go attack the businesses on the top end, but in terms of the interplay between the economic community and its impact on people's lives, there's a bottom level or a part that can't be missed.

What we hear in the report and what it's ignoring in the global community is that there's a reliance on things like competition, free markets, and market forces to make everything all right for everybody. It says that the consumers all by themselves are somehow empowered beyond what they truly are. It says that this is their power. Parliament is their power. Government is their power. This is where they come together and elect people to bring in policies. That shouldn't be overseen.

The Chairman: What's the opposite of competition?

Mr. Jamie Dunn: What's the opposite of competition?

Mr. Peter Bleyer: I don't know if it's so much the opposite as—

Regulation has been given a bad rap, right? How many of you ran for office promoting the re-regulation or more regulation of anything? I see we only have Liberal members of the committee here now, but even with only Liberal members of the committee, how many of you ran on that?

Let's take the smelly wrapper off regulation. What's regulation about? Regulation is about exactly what Jamie was talking about. It's about government. This is the level at which citizens come together to elect governments to act in their best interests and the public interest and actually set up a framework to protect the public interest and protect the interests of consumers. But it's more than consumers because the public interest is not just the interests of consumers.

That again is where we have trouble with the MacKay task force report. It's good on some of the band-aid stuff that's around, for example. It's not unimportant. A band-aid doesn't mean it's unimportant. For example, there's access to bank services for the poorest of Canadians, and so forth.

But the problem is that if you continue to endorse and accept this myth that the free market is going to handle everything—the task force report is just replete with this language—then what you're doing is actually taking these band-aids and attaching them to this monster, which just creates and recreates this problem.

You referred to competition. Well, competition has been put forward as the objective over and over again of changes to regulation, which means deregulation, over the last number of years. Look at the changes to the Bank Act, whenever they've been brought forward. What's the justification that the average Canadian is given for these? They're told they will see more competition, and that's what they'll get out of it.

What have they seen? Well, they haven't seen competition. They've seen a series of progressions in terms of takeovers and so forth, monopolization, and a concentration of ownership that's led to the point we're at today, when we're seeing the biggest attempt at monopolization and concentration that we've seen in a long time.

The Chairman: Where do you draw those conclusions from? Which page of the report is it? The MacKay report speaks to developing an entrepreneurial system that would make it easier for financial services start-ups, which means there are going to be more places where you can go and where you'll have greater choice.

• 2215

You also have the consumer package, which I think is pretty extensive, that addresses all the issues you're speaking about, such as access to basic banking for low-income Canadians and an ombudsman. The consumer package is very extensive and strong.

Mr. Peter Bleyer: But Canadians aren't just consumers. You know that because Canadians don't elect you as consumers, but as citizens. They are members of communities. I think Jamie wanted to speak to this, but I just think it's an important point. We're consumers, yes, but we are more than consumers. People who join the Council of Canadians don't self-identify as consumers alone. They perhaps do self-identify as consumers, but they identify as more than that.

Mr. Jamie Dunn: I was just going to also deal with the issue of consumers. I think when you get into the problem of over-identifying on the issue of consumers, you get into this kind of twisted logic about who government serves in its regulatory process. Governments should not be accessible to people on the basis of the extent of their consumption. In other words, they shouldn't get access to more and more and more laws just because they're out there buying and buying and buying more and more and more.

That's where we get back to the fundamental identity of who we're addressing and what we're trying to make sure is available in our community to everyone. Certainly there should be protections against consumers. Certainly, as you'll read in our brief, we support where the document has gone after those issues. We are supporters of the Canadian Community Reinvestment Coalition. They spoke at length about those issues.

What we're saying is that in the fundamental regulatory process, you can't single out people as consumers because, frankly, there are so many people who have such a small ability to consume that this means regulation isn't available to them and they're not the focus of regulation. We think that's an improper view.

The Chairman: So how is giving basic access to low-income Canadians inconsistent with your point of view?

Mr. Jamie Dunn: None of those points are inconsistent, but it won't work. In the long run, if what we're looking at here is undermining the capacity of this and future Canadian governments to regulate, then we would argue that mergers, foreign entries, and further deregulation feeds more deregulation and undermines the capacity of governments to act on the behalf of citizens. This means that any short-term, band-aid solutions on micro-issues, such as that one—these are important issues that we agree with—won't work in the long run. They're not addressing the big picture. The big picture problem is that what we're looking at is concentration of power, economic and political power; what we're looking at is undermining, with the problem of jurisdictions and so forth with the entry of foreign banks, future governments' ability to re-regulate.

For example, should this government decide to allow more foreign ownership and so forth, what in fact you would be doing is probably precluding the long-term capacity of future governments, of whatever party, to impose higher levels of regulation to protect Canadian communities, because the kind of power you would be creating—first of all, concentration of power, but secondly, the kinds of jurisdictional problems with banks not being resident here and so forth—may be very difficult to overcome.

So we think there's a fundamental— There has to be a point at which we stop this train before it heads off the cliff. We think the responsibility of this government is actually quite important, because we're at a point in history where we may not be able to turn back. Again, one of the things we like about MacKay is that it's a point at which we're all kind of saying the status quo doesn't work. But from the status quo there are a whole bunch of different ways to go. The problem is MacKay is not going, we don't think, entirely in the right direction.

The Chairman: Let me ask you a question in reference to profits.

A voice: In reference to—

The Chairman: Profits. I can use that word, right? Profits—

Mr. Jamie Dunn: Profits—well, let's see what happens in the next few weeks.

The Chairman: You know that banks and financial services sector players in Canada—I'm talking about our own—generate quite a bit of profit abroad. That money comes back here as profits. It gets taxed. That revenue is also used to sustain social programs and to help individuals, who I am sure you care a great deal about. That's one of the realities of our financial services sector. I think it's as high as 40%, and 90% of the jobs are here, and 80% of the jobs are in this country.

• 2220

So if you were to define a sector that really is beneficial to Canadians—I'm talking about in the sense of profit and the generation of wealth—then it would be the financial services sector.

Mr. Peter Bleyer: In that case, we should probably look at the record of Canada's major chartered banks in the 1980s when, among other things, they made some serious efforts to establish operations in other countries, which they used as safe havens, effectively, in order to then make loans from those locations to escape Canadian taxation as far as they possibly could.

Our argument here is that we're not counting on the banks or any other corporation. We don't think it's written in their mission statement that they have to protect the public interest. That's not their job; that's your job.

But I think it's an important point. It's not up to Canada's chartered banks, and in fact we think there should be more stringent regulations imposed on them, because clearly there have been times in the very recent past, the 1980s, for example, when many of the loans that went bad did not come straight from Canada; they came from safe havens. I don't want to get into specifics because I may not exactly get the right country, but specific countries were used by these banks. They were looking after their bottom line.

What we have to ensure is, as they seek the highest possible profits, which they have a right to seek as they try to serve their shareholders, the Government of Canada is there establishing the kind of regulations that say those aren't your only obligations; we've protected you and coddled you for years.

We're at a point where we have two choices. We can say we've coddled you too long; we're going to let a bunch of big foreign banks come in and beat you up, which may make you feel good—I don't think it would, actually—but it wouldn't serve Canadians. Or we can say it's about time we made you serve the best interests of Canadians. So that's what we're saying regulation is about.

There's no argument about the potential role that the financial services sector could play in Canadians' best interests, but we're not counting on them to do it. We're counting on government acting on our behalf to establish the kinds of regulations that force them to do it.

The Chairman: That's very clear. I think the role of legislators is to protect the public interest. To me, that's motherhood; it's a given.

Mr. Peter Bleyer: Deregulation is not, because the role of legislators in this country and others for the last 10 to 15 years has been to remove their own capacity to act on our behalf. I've been doing this kind of stuff for a while, and we're kind of tired of the fact that, in many instances, public representatives haven't been doing that. They've been finding every possible way, and sometimes it's incredibly strange to see governments dismantling themselves, people eliminating their own jobs. At one point I was kind of wondering whether Paul Martin wanted to eliminate his job as finance minister in terms of the degree to which we were moving towards deregulation, not necessarily in the financial services sector but in other places, or previously Mr. Axworthy with the social policy review, and so on.

So it has been a strange time for those of us who advocate on behalf of the public interest, because there have been days when we wondered if we could count on legislators to go in that direction, not casting aspersions on those present, but just the general context we've been in for 15 or more years.

The Chairman: Thank you.

Ms. Bennett.

Ms. Carolyn Bennett: I would like to say that a lot of the witnesses, regardless of their criticisms of the Canadian financial situation, have to acknowledge that it is one of the safest in the world and that there is regulation taking place. We heard from OSFI today. In terms of safety and soundness, I think this is a very safe place for Canadians to put their money in the bank and know it will be there when it's time to take it out.

In my riding I have a lot of widows who have their money in bank stocks. Over half of Canadians, either directly or indirectly, have their savings or their pensions in bank stocks.

• 2225

I'm from Toronto. It's obviously a financial centre. One in five accountants and one in five lawyers work for a bank, so it's very difficult to accept that government has not taken regulations seriously. When you talk about banks as a public institution, it's very interesting, because people view the banks with the same security they view public institutions, in spite of the competition. Most public institutions, frankly, are monopolies with huge regulations.

I think we're hearing that there is huge satisfaction. Even though people like to pick on the banks, there's huge satisfaction in the safety and soundness of the system. A lot of people are pretty happy they're able to make some profits.

In terms of the future, I don't know what more regulation you would want. In terms of the real reason for regulation, which is safety and soundness, we're doing a pretty good job. They're saying today there's little risk in letting more players in and giving better opportunity for consumers, in terms of small start-up banks, or letting the credit unions get a bit bigger—those kinds of things. There may have to be a little more risk taken, and that's really what MacKay was saying about the regulations.

Mr. Peter Bleyer: I don't think we can let the banks off the hook. First of all, it is true that if you compare our situation to the Russian context, there's no comparison—or the American context in many ways. The fact that that's the case despite deregulation over the last 10 or 15 years is kudos to us. Our system was so good 15 years ago that despite the fact that we've been hacking away at it, it's still looking good on a comparative basis.

One thing we could reinstitute is a federal reserve requirement. That would be a nice move in the right direction. But we can't let the banks off the hook. We're talking about taking some more risks here, but frankly the banks have been doing pretty well in terms of their profitability.

There are questions as to the real ownership of the banks. We hear often about the widows in Toronto, Montreal, or elsewhere who hold ten shares of the Bank of Montreal, but we don't really have all the numbers on how widely held the banks really are. I suspect it would be interesting to see that. Profit is not a dirty word, but the outrageous profit numbers of the banks in many instances over the last number of years would lead one to believe there is room within that profit margin for us to do some things without risks.

Isn't there room there for us to do some things? For example, we're proposing a national investment fund. That national investment fund could be funded through a small levy on above-average profits of financial institutions. It could be funded in other ways as well—a proportion of assets held with the fund, sort of the way the federal reserve requirement worked.

There's the question of the kind of interest payments that have accrued to the private banks, as opposed to being cycled through the Bank of Canada because of the lack of the federal reserve requirement since the changes under Mulroney.

The banks have been getting a good enough deal over the last number of years, and it seems to us we don't have to look at the kinds of things being proposed in terms of risk. There's room there to get any changes that are necessary out of the cream the banks have been scooping off the top.

Ms. Carolyn Bennett: My little old ladies are happy. With interest rates where they are at the moment, they're happy the banks are making some money. It helps them with their little problems with their incomes, right?

Mr. Jamie Dunn: Then again, this isn't about punishing banks or punishing anyone in the financial industry.

• 2230

You talked about the history of stability in the Canadian banking industry, and the part of the report that concerned us was the direct reference to having to address the balance between stability and risk and innovation.

The explicit intent of the report is to change the balance toward risk and innovation right now because of the wonderful global marketplace and, as I mentioned before, the very positive attitude. We were alarmed by the report because it didn't recognize the realities that were taking place while it was being written. We thought that wasn't balanced. To have that kind of general theme and then in turn to be saying we should be rushing to risk and innovation, going away from that balance and letting stability go the other way on the scale we don't think is a good idea.

Ms. Carolyn Bennett: Like the conversation we had about the ATMs, couldn't the risk go to something that might serve consumers well but not make money and so—

Mr. Peter Bleyer: We should define risk and innovation. What we hear risk and innovation being defined as is kind of like what we hear globalization being defined as—or being avant-garde, as your colleague from the Bloc Québécois suggested. It's risk and innovation for what? When we heard the vested interests come to this table, you remarked, or one of the members of the committee did, in terms of what was being put forward, what is Interac looking for? Interac and any of these associations or corporations are looking at their bottom lines; it's risk and innovation to improve their bottom lines. It wouldn't have to be risk. We could just talk about innovation to improve access to capital for needy communities. The national investment fund would fit into that. You wouldn't have to risk anything. You'd basically just have to say to the banks, “This tiny percentage of these excess profits goes into this fund”. There would be zero risk, tons of innovation, and great results. So it's risk and innovation for what? That's really what it comes down to, I think.

Ms. Carolyn Bennett: I feel there's a risk involved in anything to do with consumers. If you build it, they will come. If you build it and they don't come, that's a risk in terms of trying to predict what consumers might want. I just think we shouldn't inhibit that.

Mr. Peter Bleyer: Consumers, right? Again, it's not just consumers, because our national investment fund is not about consumers. There's a question of consumers for sure, but really, what could potentially get lost in all of this is the quasi public utility function of the banks.

On the eve of the 21st century, the new millennium, it seems to me the functions banks occupy in our society are similar to national security in previous generations. We have to take really seriously the access to capital and the ability to invest, create jobs, and so forth. These are too important to be left to the banks, to these private interests alone.

Ms. Carolyn Bennett: Sell insurance and lease cars.

Mr. Peter Bleyer: We don't particularly like any kind of further concentration, vertical or horizontal, because of the power that accrues to those corporations. Put that one in there.

The Chairman: I'm advocating we make a recommendation that we split all the major banks into four. If you're concerned about concentration and you think it's already concentrated, why don't you—

Mr. Peter Bleyer: We think the solution can be found in regulation. You made the point that some public utilities are monopolies and some of them work really well. It's really the degree to which this stuff— These are powerful private sector corporations, despite the fact that they have these functions that are akin to those of public utilities. We're not dreaming in technicolour; we don't think these are going to become real public institutions. They are private sector corporations.

We're also quite realistic about where the political will would come from. I'm not sure if that would be where we would put our emphasis on breaking up the existing banks. We would put our emphasis on having governments that have the ability and guts to place the kinds of rules that force those banks to act in the best interests of Canadians as a whole and those specific communities. We can do that without breaking them up into four banks each. I don't think there's a government today or in the near future that would be willing to take up that kind of a challenge. We're not crazy.

• 2235

The Chairman: You talked about excess profit and you said somehow you should tax. First of all, we do tax—I think it's above $100 million—above and beyond the regular tax. With what measurement do you determine whether it's excess profit or not?

Mr. Peter Bleyer: I think we'd refer you to a document whose formulation we participated in, the alternative federal budget, which over the last number of years has come up with a number of different formulas for taxes on excess profits of financial institutions, and a variety of other tools designed both to generate the kinds of resources necessary for the social programs and so forth that you've referred to, and to level the playing field in terms of the excess profits. So we'd refer you to the alternative federal budget, which has a whole series of proposals on this.

The Chairman: When bankers come in front of our committee, they say their return on equity would be in the middle—I'm talking about the various industries now. Should they not care about the return on equity?

Mr. Peter Bleyer: Yes, they should care about the return on equity; that's their job. They should care about ensuring you do as little as possible to undermine their ability to maintain maximum profit, return on equity, return on assets, and all the various ratios that are used and can be constructed one way or the other.

The question is, what can be determined as being acceptable, given the other obligations that we have as a society? We can come up with proposals, but obviously there's going to be a debate about where you draw the line. We'd be pretty happy if the principle that there should be a tax on excess profits were accepted and if there were some kind of agreement on that. Then we'd get down to how this is implemented and the exact numbers.

I would die of shock if the CEO of a major bank came in here and didn't protect their right and need to maximize profits, however they are measured in terms of ratios and so forth. There's nothing new about that. The question is, what do we determine is in the public interest, and where do we go from there?

The Chairman: Okay. On behalf of the committee, I'd like to thank you very much.

The meeting is adjourned.