June 23, 2003

Response of the Government to

Large Bank Mergers in Canada: Safeguarding the Public Interest for Canadians and Canadian Businesses

a Report of the House of Commons Standing Committee on Finance

and

Competition in the Public Interest: Large Bank Mergers in Canada

a Report of the Standing Senate Committee on Banking, Trade and Commerce

• Adobe Acrobat Version .(294,317 bytes)

Related documents:

• Large Bank Mergers Consultation.
• Minister Manley Releases Response to Commons and Senate Committee Reports on Bank Mergers and the Public Interest. (News Release 2003-031)

Introduction 

A. Public Interest Considerations in Reviewing Bank Merger Proposals 

Role of the Minister of Finance and the Public Interest 

Clarifying the Public Interest 

Clarifying the Public Interest Review in the Bank Merger Review Process 

B. Additional Significant Financial Services Sector Issues 

Overview of Canada's Financial Services Sector 

Cross Pillar and Large Insurance Company Mergers 

Possible Guidelines for the Future Structure of the Canadian Financial Services Sector 

Process for Reviewing Multiple Merger Applications 

Measures to Enhance Competition 

C. Next Steps 

Annex A
Letter to the Committee Chairs From the Minister of Finance and Secretary of State (International Financial Institutions) 

Annex B
Bank and Life Insurance Structure in Canada and Selected Other Industrialized Countries 

The Government would like to express its appreciation to the House of Commons Standing Committee on Finance, chaired by Ms. Sue Barnes, MP, which presented the report entitled Large Bank Mergers in Canada: Safeguarding the Public Interest for Canadians and Canadian Businesses, and to the Standing Senate Committee on Banking, Trade and Commerce, chaired by the Honourable Senator Leo Kolber, which presented the report Competition in the Public Interest: Large Bank Mergers in Canada. The Government would also like to thank the numerous witnesses for their efforts and interest shown in these studies of public interest considerations in reviewing large bank mergers.

Canada's financial services sector is one of the most important sectors in the Canadian economy, and it will play a critical role in Canada's continued economic growth.

Canadian financial institutions are active internationally and increasingly have to face the challenges posed by technological innovation and globalization, which have spurred consolidation in the financial services sector around the globe. Technology and innovation are also changing how institutions compete, how people access financial services, and their choices among financial service providers.

At the same time, there is a significant level of convergence occurring within the financial services sector with, for example, banks and insurance companies offering a variety of similar services.

In this increasingly complex environment, Canadian banks and other financial institutions are considering mergers as an option to enhance their international competitiveness and facilitate their strategies for international growth. While the Government supports the notion that mergers can be a valid corporate strategy, the prospect of mergers among Canada's large financial institutions raises important public policy issues.

For this reason, when the Government introduced legislation in February 2001 to establish a reformed policy framework for the financial sector in Canada, it issued guidelines governing the review process for mergers among large banks, that is, those with more than $5 billion in equity. The guidelines require merger proponents to provide a public interest impact assessment in respect of their proposed transaction and outline criteria by which the Minister would assess the public interest impact and related policy issues.

More recently, industry participants have requested that the Government's merger review guidelines be reviewed to update and, where possible, clarify the public interest considerations. In response, in October 2002 the Government asked the House of Commons Standing Committee on Finance (hereafter the House of Commons Finance Committee) and the Standing Senate Committee on Banking, Trade and Commerce (hereafter the Senate Banking Committee) to provide their views on the major considerations that should be borne in mind by the Minister in determining whether a bank merger proposal is in the public interest. During the course of the hearings of the two committees, witnesses addressed the public interest factors, and the committees' reports have provided valuable advice to the Government in respect of those issues. However, a number of witnesses expressed strong views that the public interest considerations should not be assessed in isolation, but that other key policy issues relating to the financial sector should be addressed concurrently.

The basic premise of some of those who called for these additional considerations was that the Government should, in addition to clarifying the public interest criteria, determine whether there are any structural imperatives relating to the financial sector and, if so, it should make these clearly known to the industry prior to institutions initiating merger proposals. Others urged the Government to re-evaluate the existing policy which precludes mergers between large banks and large insurance companies in order to widen the range of strategic options. The issue of how to deal with a "first mover" advantage in any merger review process was also raised. Finally, a number of witnesses made the point that merger proposals should be accepted and assessed by the Government against the backdrop of a public policy framework which, as comprehensively as possible, encourages robust competition in the sector.

The Government has concluded that, based upon the work of the committees, it is now able to provide a final statement of the public interest considerations which should apply in the case of any merger proposal and the role that the committees should play in assessing these considerations. It has also concluded that it should carefully evaluate and, after analysis and consultation, respond to the other very important issues which have been raised before the committees. The Government believes that only by so doing will it be able to provide the financial services sector with a clear framework within which to do its strategic planning. In addition, this further review will assure the Canadian public that the Canadian financial services sector will continue to be robust and competitive.

This paper does three things:

• Part A sets out the Government's response to the advice received from the House of Commons Finance Committee and the Senate Banking Committee regarding the public interest considerations that should apply in a review of a large bank merger proposal. It provides greater clarity on how the public interest will be assessed in a merger review.

• Part B identifies and seeks input on the other key policy issues raised by the committees and in hearings, beyond the scope of the original request that sought their views on public interest criteria. These issues relate more generally to the structure of the industry and competition in the sector.

• Part C provides a precise timetable for action with regard to merger proposals so institutions can manage their business planning more effectively.

A. Public Interest Considerations in Reviewing Bank Merger Proposals

Role of the Minister of Finance and the Public Interest

Under the current large bank merger guidelines, the Competition Bureau reviews the competition implications of a transaction, the Office of the Superintendent of Financial Institutions (OSFI) examines the prudential implications and there is a public interest review with the Minister of Finance having the final decision, drawing on this advice.

In its report, the Senate Banking Committee recommended that the Minister of Finance approve any mergers that have been approved by OSFI and the Competition Bureau, unless there are compelling reasons not to do so-suggesting that once these reviews are complete, there would be few remaining considerations related to the public interest.

The Government believes that there is a need for a broad public interest review of any bank merger proposal that goes beyond the OSFI and Competition Bureau reviews, and that the Minister of Finance, as the Minister responsible for the financial sector and capital markets, is the appropriate person to review the full range of relevant issues, weigh the benefits and costs of a merger proposal and make a final decision.

This approach to reviewing bank mergers is appropriate given the special status afforded financial institutions by Parliament under federal legislation, and the role that they play in the Canadian economy and Canadian capital markets.

Banks in Canada are regulated for good reasons-for safety and soundness and to protect consumers. Regulation provides a degree of protection and stability that leads to confidence in the institutions and in the financial system more generally. The regulatory framework, including the dual protection of deposit insurance and the supervisory regime, engenders a degree of public trust in banks, from which these institutions benefit. With these benefits come certain responsibilities to the Canadian public.

Many witnesses at the committee hearings noted that Canada's large domestic banks play a unique and pervasive role within the Canadian economy and Canadian capital markets. For example:

• they take the large majority of deposits from Canadians, safeguard their savings for retirement, and finance the purchases of homes and cars, while also assisting businesses to meet their payrolls, buy inventory and expand their operations;

• they play a pivotal role in providing financing to small and medium-sized enterprises (SMEs);

• they support innovation and growth in Canada;

• they provide economic infrastructure in rural regions of Canada; and

• they play a significant role in our domestic bond and equity markets.

The last point deserves particular comment. Canadian banks, through their securities subsidiaries, play a key role in Canada's capital markets. From such a dominant position, they have a great deal of influence on the depth and strength of those markets and their ability to finance economic growth in Canada.

For these reasons, mergers involving large banks in Canada are not like mergers in other industries. They raise special concerns that justify a broader public interest test. This is especially true given the degree of existing concentration in the Canadian banking industry and the possibility of multiple merger applications, which have the potential to significantly alter the landscape of the financial sector in Canada. The Government agrees that the banks are best positioned to decide whether a merger makes good business sense. But given their special status and role in the Canadian economy, the public policy issue is whether a merger is in the public interest and how Canadian consumers and businesses will benefit from a merger.

The Minister of Finance is the steward of the public interest in the review of mergers involving federal financial institutions and is responsible for the policy framework for the financial sector in Canada. The Minister also has a continuing responsibility to ensure that domestic capital markets are functioning efficiently. The Government believes that the public interest considerations in the merger context reflect these roles and responsibilities.

Clarifying what the Minister of Finance should consider in the context of a public interest review was the reason for the request to the committees in October 2002 (see letter in Annex A).

The House of Commons Finance Committee and Senate Banking Committee hearings confirmed that there is no simple black and white answer to the question of what public interest considerations should be taken into account by the Minister of Finance in making a decision respecting a particular bank merger proposal. The Government has reviewed the testimony at the committees' hearings and their recommendations.

The Government has concluded that the Minister should consider the following five public interest criteria in making a decision on a proposed merger among large banks:

Access

A critical aspect of the broad public interest is the access Canadians have to financial services. Convenient access to high quality financial products and services using technologically sophisticated approaches is a must for any growing economy.

Access, by whatever means, must be broad-based and cannot be limited to a select few. Rural and low-income communities are of particular concern. The Minister also needs to consider the banks' strategies for addressing the challenges facing Canadians with special needs, such as people with disabilities, seniors and people with lower incomes.

It is reasonable for the Minister of Finance to ask how and to what extent the greater public good can be enhanced following a bank merger.

As such:

Choice

Robust choice among financial service providers benefits Canadian consumers, businesses and the broader economy. It ensures that a wide range of financing options is available to individuals and businesses in the economy.

In the context of the public interest review, this matter of choice goes beyond the issues that would be examined by the Competition Bureau in considering whether the transaction would likely lead to a substantial lessening of competition through the potential for raising prices or limiting product offerings.

For businesses and individual Canadians, it is very important to have multiple service providers to choose from when making the case for obtaining a loan.

In this context, SMEs, which account for roughly 45 per cent of Canada's economic output, depend heavily on the banks for services and financing. For such businesses, it is especially essential to maintain a marketplace where there are a number of financial service providers to help ensure that there is a diversity in terms of lending philosophy and related credit risk assessment and pricing.

Merging institutions should have a strategy that ensures that a bank merger does not unduly compromise choice among financial service providers.

In particular:

International Competitiveness and Long-Term Growth Prospects

Canada has a competitive financial services sector, and the Government wants to build on this, both for the sector itself and for the rest of the economy, which the sector serves.

Mergers have the potential to improve the competitiveness and enhance the long-term growth prospects of the large banks by improving their efficiency (for example, by allowing them to achieve economies of scale and scope), giving them more critical mass to compete in particular areas where size is important, increasing their capital, and providing a broader set of strategic options for growth.

In addition, as Canadian companies grow and expand abroad, banks need to be well positioned to meet their customers' financing and merger and acquisition needs through greater availability of financing and/or more sophisticated forms of financing at home and abroad.

In the domestic market, Canadians expect access to products and services that reflect international best practice. Canadian financial institutions that are competitive abroad can learn from their experiences, employing their expertise and technology to enrich the depth and quality of their product and service offerings for individual Canadians and Canadian businesses.

The benefits to Canadians of a strong, internationally competitive banking industry are clearly enhanced by maintaining the mind and management of the financial institutions in Canada. This would be bolstered by a strategy for recruiting and keeping the best and brightest financial minds in Canada, building on the skills of financial sector employees.

For all these reasons, the Government believes it would serve the public interest to have financial institutions that are internationally competitive and that have a platform and strategy that support the long-term growth of high quality jobs in Canada and the role of the sector as a major Canadian industry in its own right. Demonstrating this is a key public interest criterion.

As such:

Capital Markets

Success in realizing greater international competitiveness and enhanced growth prospects for Canada is related to both international and domestic capital market issues. Canadian financial institutions play an important role in capital markets both at home and abroad, and mergers could have consequences for Canadian capital markets.

Banks play a significant role in debt financing, and are also major players in capital markets through their securities subsidiaries, merchant banking arms, mutual fund operations, and venture capital funds and investments.

Canadian companies must have access to a strong, innovative and efficient domestic financing base. A strong domestic capital market will ensure that Canada is equipped with one of the important tools needed to ensure Canada's economic prosperity.

Canadian companies require a full spectrum of competitively priced financing options to meet their needs at every stage of development. Consumer credit, such as home mortgages, also benefits from sound capital markets, which help to finance consumer lending. Capital markets are also increasingly vital to the vast and growing number of Canadian investors, who require a range of investment opportunities to meet their various investment objectives.

Canada's debt and equity markets are well developed but need to address a number of challenges in the context of increasingly integrated international markets. Improved access to foreign capital markets has vastly improved Canadians' financing and investment opportunities. But Canada needs strong domestic capital markets to enable Canadian companies of all sizes to prosper.

An important public interest consideration is how changes to the banking industry would contribute to the broadening and deepening of capital markets in Canada. It is therefore appropriate to include a public interest consideration that directly addresses these issues.

The large banks are major employers in Canada. In 2000, Canadian banks and their subsidiaries employed 235,000 Canadians. These men and women make a significant contribution to our national economy and need to know that their interests will be taken into account in any bank merger review.

The Government recognizes, however, that adjustment will be an inevitable consequence of mergers.

The displaced employees of merging banks should be treated in a fair and reasonable manner. In the event of involuntary job losses, the banks would be expected to provide severance and early retirement packages, as well as other transitional services, including training and relocation.

During the course of the committee hearings, witnesses testified that the roles and responsibilities of the Competition Bureau, OSFI, the committees and the Minister of Finance in the merger review process should be clearer. There were also concerns expressed that at the end of the review, the Minister of Finance could still turn down a merger on public interest grounds. Questions were also raised concerning the role of the House of Commons Finance Committee and Senate Banking Committee in the overall decision-making process.

The Government recognizes the need for clarity concerning the roles and responsibilities of the Competition Bureau, OSFI, the House of Commons and Senate committees, and the Minister of Finance, and agrees that it is desirable to provide an approach outlining how all of these pieces fit together with minimal duplication.

Roles of the Minister of Finance, Superintendent of Financial Institutions and Commissioner of Competition

The Minister of Finance is ultimately responsible for approving any bank merger application and imposing whatever terms and conditions he or she believes are appropriate to ensure that the merger would be in the public interest. The Minister must weigh the different prudential, competition and public interest impacts of the transaction to formulate an overall decision on whether the merger proposal should be permitted to proceed, and what terms and conditions are appropriate.

On prudential matters, the Minister will receive the views of the Superintendent of Financial Institutions and carefully consider this input in formulating the decision.

On matters of competition, the Minister will receive the views of the Commissioner of Competition and carefully consider this input in formulating an overall decision on the merger application.

Role of the House of Commons and Senate Committees

With regard to the public interest review, suggestions were made that the House of Commons Finance Committee and Senate Banking Committee could be dropped from the review of a specific proposal. The Government believes, however, that these committees should continue to be involved both as a forum for public input and a source of expert advice to the Minister of Finance regarding public interest policy issues.

In terms of the overall timeline for the merger review process, the Government continues to believe that giving the Minister of Finance five months to make a decision is appropriate.

However, the process can be made more effective by reducing any possibility of overlap and ensuring that the committees provide advice in those areas where it would be most helpful to the Minister. In this regard:

Review of the Competition Bureau's Approach to Bank Mergers

In 1998 the Competition Bureau released a version of its merger enforcement guidelines to deal specifically with large bank mergers. These were entitled "Merger Enforcement Guidelines as Applied to a Bank Merger" and are sometimes referred to as "BMEGs."

The BMEGs set out the analytical framework used by the Competition Bureau when assessing the competitive effects of a merger involving two or more banks. This includes, for example, the process of defining relevant markets and applying market share and concentration threshold tests to determine if further competitive analysis is warranted.

Much has happened since these guidelines were released, including reviews of financial sector mergers in Canada and in other countries by their antitrust authorities.

As noted in the introduction to this paper, witnesses appearing before the House of Commons Finance Committee and the Senate Banking Committee raised a number of wide-ranging and important issues that went beyond the Government's initial request for advice as to how to best clarify the public interest considerations to be addressed in bank mergers. The premise of these presentations, which was also reflected in the reports of the two committees and other public comments by industry stakeholders, was that the Government ought to address other key questions prior to considering specific merger proposals.

In particular, it was argued that the best way to provide better focus for large financial institutions considering a consolidation transaction would be for the Government to specify in advance any financial sector structural features which the Government considered essential to exist at the conclusion of any such transaction. It was suggested that a more well-defined view of the structure of the sector going forward could, in fact, prove to be the most helpful clarification to guide both institutions and the Minister in assessing proposals. Those who suggested that such a broader view should be taken noted that this should include a careful reconsideration of the policies relating to mergers among banks and insurance companies, how the Government would deal with multiple mergers, and other issues impacting competition in the sector.

The Government has considered these additional ideas very carefully and it agrees that they should be addressed prior to any consideration of large bank mergers.

As a result, the Government seeks public input on the issues outlined below. The Government would welcome the views of the House of Commons Finance Committee and the Senate Banking Committee on any or all of these issues, should the committees wish to provide further comments.

To provide context for the issues discussed in Part B of this paper, it is helpful to examine the current nature and structure of the Canadian financial services sector. The Canadian financial services sector is made up of banks, trust and loan companies, credit unions and caisses populaires, life and health insurance companies, property and casualty insurance companies, securities dealers and exchanges, mutual fund companies and distributors, and finance and leasing companies, as well as independent financial advisors, pension fund managers and independent insurance agents and brokers.

The financial services sector makes important contributions to the Canadian economy. Representing over 5 per cent of Canada's gross domestic product (GDP) in 2000, the sector's GDP share has been increasing steadily since the mid-1980s, with the highest growth occurring in the bank and deposit-taking sector. The financial services sector also employs roughly 540,000 people in Canada.

The sector is characterized by a large number of diverse companies providing a broad range of financial services to Canadian consumers and companies. However, as the following table highlights, Canada has a small number of very large players in the financial services market. In recent years Canada's insurance companies have grown to be as large as some of the major banks.

The financial services sector makes up a large and growing component of the Toronto Stock Exchange. In 1995 the sector accounted for approximately 15 per cent of the market capitalization of the Toronto Stock Composite Index. It has now risen to approximately 33 per cent of the index.

At present, both the banking and insurance industries in Canada are characterized by a relatively small number of large institutions (with substantial market shares in most retail financial products) and by a number of other relatively small, but still significant, providers. One way to view the present industry structure is through the lens of the ownership rules for large financial institutions, which distinguish among those institutions with more than $5 billion in equity, those with $1 billion to $5 billion in equity, and those with less than $1 billion in equity.^[1]

Viewed against the perspective of this regulatory framework, the current structure for federally regulated institutions is set out in the following table:

Canada's banking market is more concentrated than in many other developed countries, including the United States. The five largest banks account for approximately 65 per cent of retail deposits. The second-tier institutions are important players in several regions of the country, notably in the western Canadian provinces and Quebec, where the credit unions and caisses populaires account for 20 to 40 per cent of the assets of deposit-taking institutions.

Currently each of the five largest banks in Canada accounts for between 10 and 15 per cent of retail deposits, with institutions such as the National Bank of Canada, Laurentian Bank of Canada and HSBC Bank of Canada each accounting for 2 to 4 per cent of retail deposits.

Banks are also dominant in the SME lending market, accounting for about 56 per cent of all business loans under $1 million in authorization in 2001. Similar to other product markets, the five largest Canadian banks represent a large proportion of the bank share, at about 77 per cent.

In terms of the domestic insurance market, the five largest life and health insurance companies account for 65 per cent of domestic assets, excluding segregated funds. Sun Life is currently the largest company, accounting for nearly 23 per cent of domestic assets. It is followed by Manulife and Great-West Lifeco (including London Life), both at approximately 15 per cent of domestic assets, and Canada Life, with 7 per cent of domestic assets.

These banks and insurers form part of an evolving Canadian financial services sector with an ever-increasing international reach. The foreign activities of Canada's financial institutions have increased significantly since the early 1990s, as shown below.

In addition to the evolution in structure, size and international scope of financial institutions, the demands of Canadian consumers are also changing. For example, the graph below shows how Canadian consumers shifted savings into mutual funds and equity markets over the 1990s. They have recently retreated to some extent from these same markets. This volatility demonstrates the changing nature of consumers' demands and the need for financial institutions to be equipped to adjust to these demands.

At the same time, there is a significant level of product convergence occurring within the financial services sector. This has resulted in some companies choosing to diversify their product offerings and develop scope to meet consumer demands, thereby leading to the emergence of large, complex "financial groups." These groups, particularly prevalent in the banking and life and health insurance sectors, offer a wide variety of financial services such as deposit taking, insurance and wealth management both directly and through subsidiaries. Interestingly, other companies have chosen an alternative competitive path, pursuing only one or a few business lines in the context of their business strategy.

These developments have important implications for the competitiveness of Canadian financial institutions, the strategic decisions they must make and the appropriate policy framework.

Cross Pillar and Large Insurance Company Mergers

In 1999 the Government passed legislation to allow federally incorporated mutual life insurance companies to convert into stock companies-a process known as demutualization. Canada's four largest mutual insurance companies (Sun Life Financial, Clarica Life [now part of Sun Life Financial] Manulife Financial Corporation and Canada Life Financial Corporation) have demutualized.

As a matter of policy established in 1999, mergers or acquisitions between or among large demutualized insurance companies and large banks (i.e. those with over $5 billion in equity) are not permitted.

This policy ensured that the large demutualized insurance companies would have sufficient time to adjust to a new form of ownership in a public market, while at the same time ensuring strong independent insurance companies in Canada.

One of the guiding principles of the latest round of financial sector reform was to offer more flexibility to the financial services sector. Therefore, Canada's policy with regard to insurer consolidation was not legislated so it could be changed if circumstances warranted.

Since demutualization, the large insurance companies have grown substantially and now have similar market capitalization to some of the large banks. There has also been significant consolidation in the sector since 1999. Furthermore, product offerings across the bank and insurance sectors have become increasingly competitive.

At the committee hearings, some witnesses indicated that it would be useful to change the Government's policy with regard to the demutualized insurers. They noted that this would allow Canadian financial institutions, both insurers and banks, to consider a fuller range of combinations and future growth opportunities. Some witnesses at the committee hearings indicated that it would be useful for financial institutions to have the full array of structural options, including cross pillar mergers, available to allow institutions a complete assessment of strategic decisions in the increasingly competitive global financial services market. Other commentators have expressed the view that mergers between banks and insurers would offer little to shareholders and would not serve the public interest.

The Government wishes to have views as to the potential impact of such policy changes on the structure and competitiveness of the sector and whether they would be in the public interest.

In considering any policy changes with regard to the demutualized insurance companies, the Government does not intend to consider changes to the insurance networking restrictions, which limit the ability of banks to sell insurance through their branch networks.

During the hearings before the House of Commons Finance Committee and the Senate Banking Committee, and in other public statements, industry participants and commentators have raised the question of whether some structural definition would be useful and, if so, how it would be achieved. There were very few concrete suggestions made, however, as to what specifically should be considered in this respect and why.

For example, comments have been made about the number of mergers that could take place in Canada without necessarily creating a negative public interest result. In its report, the Senate Banking Committee expressed the view that a bank merger that reduced the number of large banks to four might be acceptable given appropriate circumstances. It added that a merger (or mergers) that reduced the number of large banks to three may be satisfactory, but that mergers resulting in only two large banks would be unsupportable.

The Senate Banking Committee wondered whether there should be express limits placed on the number of mergers that would be permitted in Canada. Other commentators have suggested that if the Government wanted to limit the number of mergers or place other constraints on potential mergers, then these limits should be clearly outlined in advance to provide greater certainty in business planning.

Some large industrialized countries, such as the United Kingdom and the Netherlands, are characterized by having three or four large banks (see Annex B). Certain countries, including Australia and the U.S., have established that, because of the importance of the banking sector, it is appropriate to have constraints on the number or size of merging institutions. Australia currently has a moratorium on mergers among its four large banks, while in the United States legislation prohibits a merger that creates an institution with over 10 per cent of insured national deposits.

This experience in other countries suggests that there does not necessarily need to be five or six large banks to ensure Canada has a strong, competitive, efficient and sound industry.

There is certainly a point beyond which mergers would seriously jeopardize safety and soundness, competition and the broad public interest. This is particularly so given that Canada does not have a strong national banking second tier, although, as noted earlier, the smaller federally regulated banks and the credit unions are extremely important players in certain regions of Canada.

Large retail banking institutions provide a depth and scope of service to customers that may not always be possible in smaller institutions. National coverage provides a breadth of service to Canadian consumers and businesses that require services in multiple locations throughout the country. But the importance of these geographic and product ranges, and whether they should be among any explicit structural constraints, has yet to be determined.

In the life and health insurance industry, as another example, recent and pending acquisitions have reduced the number of large insurance companies. To what extent any further consolidation involving large insurers would be desirable is an important question.

As such, the Government is seeking views on the following questions:

Process for Reviewing Multiple Merger Applications

Questions have also been raised regarding how to deal with a "first mover" advantage in any merger review process.

During the committees' hearings, some commentators said that the merger review process should not favour the first merger application that is received. At the same time, it would be unfair to the first applicants if the time frame for receiving a decision on their application was unduly delayed to provide a lengthy window of opportunity for other banks to negotiate a merger and/or submit complete applications.

In terms of process, when a merger is announced, OSFI's review would focus on prudential considerations, the Competition Bureau would look at the competition issues, and a review of the public interest considerations would be conducted. Both OSFI and the Competition Bureau are positioned to start their reviews of merger applications as soon as they are received, but there is an issue as to when the House of Commons Finance Committee and Senate Banking Committee should be asked to address the specific questions to be provided by the Minister regarding public interest considerations.

The Government believes that the merger review process should not create a "first mover" advantage. One way to deal with this would be to establish a window of time to accommodate multiple merger proposals. Before pursuing this approach, the Government would want to ensure that the total length of time for the merger review process remains reasonable. As well, it would seem appropriate for the Minister to provide the questions relating to the public interest considerations in particular mergers to the House of Commons Finance Committee and Senate Banking Committee only after this period has finished.

The Government would like to hear views regarding how to best ensure that there is no "first mover" advantage.

Measures to Enhance Competition

During the course of the hearings, the committees heard that still more needs to be done to increase competition in Canada. In addition, both the House of Commons Finance Committee and the Senate Banking Committee put forward recommendations urging the Government to do more in this regard.

The House of Commons Finance Committee recommended that the Government review the legislative and policy framework to ensure that barriers to entry and expansion are eliminated. The committee also suggested in its report that greater foreign competition might occur if regulatory barriers to entry for branches of foreign banks were lowered. It recommended that the Government take immediate steps to remove any impediments to the emergence and growth of credit unions in Canada.

The Senate Banking Committee recommended that the Government undertake a review of barriers to entry into the financial services sector-including tax changes-that would foster competition. It also noted that divestitures of assets could be used to foster the growth of existing and new competitors in the financial services sector in Canada, in the context of a particular transaction.

Recent Initiatives to Enhance Competition

In the past few years the Government has introduced a number of measures to increase competition in Canada. In 1999 the Government allowed foreign banks to operate directly in Canada through a branch of the parent bank. Furthermore, foreign banks wishing to operate in Canada are permitted to have the same range of investments as Canadian banks. They are allowed to establish more than one branch and can own more than one bank. And like the domestic banks, they benefit from the streamlining introduced into the approvals system.

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

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

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

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

Since 1999 the Government has taken significant steps in an effort to enhance competition in the financial sector in Canada. However, it is still relatively early and more time is needed to see the benefits from these changes. It remains to be determined whether still more can be done in this important area.

Divestitures

Some witnesses at the committee hearings noted that mergers can enhance competition by providing an opportunity for new competitors to emerge or for existing participants to increase market share, including foreign and small Canadian banks, co-operatives and credit unions, and single-product financial service providers.

In the context of the discussion of financial institution mergers, it is important to note that divestitures, which involve the sale of assets (including branches of banks) of the merging parties to a third party, may provide an opportunity not only to ensure that sufficient competition continues to exist following a large merger, but also to add a significant competitor either by allowing existing institutions to expand or by creating new ones.

The divestiture of bank branches, for example, is widely considered among industrialized countries as a successful approach for addressing concerns arising from a bank merger. In the Canadian context, divestitures might provide an opportunity for the creation of a new large national retail bank presence in Canada. It might also provide an opportunity to enhance the competitiveness of other competitors such as credit unions or smaller banks.

Full Functionality of ATMs

At present Canadian bank customers can make cash withdrawals from automated teller machines (ATMs) belonging to a wide variety of institutions. However, they are generally able to conduct the full range of transactions, including deposit and bill payments, only at ATMs owned by the financial institution at which they hold an account. ATM full functionality would enable individuals and SMEs to conduct the full range of banking activities (e.g. deposits, withdrawals, bill payments, etc.) at any banking machine of their choice, regardless of institution or location.

The issue of full functionality of ATMs as a means of overcoming barriers to competition in banking in Canada was raised during the committees' hearings. It was argued that full functionality would enhance competition and provide consumers with a wider range of choices for their ATM needs.

Credit Unions

The Government will continue to work with the credit unions to find ways of meeting their objectives and responding to the changing needs of the industry. Based on the flexibility built into Bill C-8, the Government is introducing regulations that support the growing aspirations of the credit union movement and individual credit unions.

Foreign Bank Entry

With regard to foreign bank entry into Canada, it is the Government's view that under the present regulatory regime, foreign banks are already afforded a great deal of opportunity and flexibility. However, there is one area where the activities of foreign banks in Canada are restricted: foreign banks operating in Canada directly through a branch of a foreign institution, rather than through a Canadian subsidiary, are prohibited from taking retail deposits of less than $150,000. While this is consistent with the policy approach in a number of other countries, the Government believes that it is time to re-examine this issue.

C. Next Steps

Last year the Government asked for advice from the House of Commons Finance Committee and the Senate Banking Committee regarding the public interest considerations that should apply in a review of a bank merger proposal. In the first part of this paper, the Government provides greater clarity to the public interest component of the merger review process by setting out public interest criteria and refining the role of the committees in the merger review process.

As noted earlier, there are a number of other key issues which the Government considers necessary to address in finalizing financial sector consolidation policy in Canada. Those issues are outlined in Part B of this paper, and further work will be undertaken, including consultations, to develop policy in these areas.

Finally, the Government has been asked to provide certainty related to the timing of financial sector merger proposals and, in particular, to define when it would be prepared to accept proposals for consideration. To provide this certainty:

Written comments can be forwarded until December 31, 2003 to:

Gerry Salembier
Director, Financial Institutions Division
Financial Sector Policy Branch
Department of Finance
140 O'Connor Street
Ottawa, Ontario K1A 0G5

Subject to the consent of the submitting party, comments will be posted on the Department of Finance Web site at www.fin.gc.ca to add to the transparency and interactivity of the process. Once received by the Department, all submissions will be subject to the Access to Information Act and may be disclosed in accordance with its provisions. Should you express an intention that your submission should be considered confidential, the Department will make all efforts to protect this information within the legal requirements of the law.

October 24, 2002 

Ms. Sue Barnes, M.P.
Chair, Standing Committee on Finance
House of Commons
Ottawa, Ontario
K1A 0A6

The Honourable Leo Kolber
Chairman
Standing Senate Committee on 
Banking, Trade and Commerce
The Senate of Canada
Ottawa, Ontario
K1A 0A4

Dear Ms. Barnes and Senator Kolber:

As you are aware, when the Government introduced legislation on February 7, 2001, to establish the new framework for the financial sector in Canada, it issued guidelines governing the review process for mergers among banks with more than $5 billion in equity. That process includes three parts. The Competition Bureau reviews competition issues, the Office of the Superintendent of Financial Institutions reviews prudential issues and the Government assesses public interest issues. In this latter regard, the House of Commons Standing Committee on Finance and the Standing Senate Committee on Banking, Trade and Commerce would be asked to conduct public hearings into the broad public interest issues that are raised by a specific merger proposal.

Since the release of these guidelines, some stakeholders have stated that the public interest tests associated with a bank merger review need greater clarity. The Government agrees, and in this regard it would be most helpful if your committees would provide us with views on the major considerations that should apply in determining the public interest.

In providing your advice, you may wish to consider the public interest implications of large bank mergers for:

• the access of Canadians in all regions to convenient and quality financial services, giving special attention to the disabled, low-income individuals and rural communities;

• the choice among financial service providers and the availability of financing for businesses, especially small businesses, and Canadians;

• the creation of long-term growth prospects for Canada through more effective Canadian-based internationally competitive institutions; and

• any adjustment or transition issues, including the treatment of employees.

The Secretary of State (International Financial Institutions) would be pleased to work with you during the course of your deliberations. It would be appreciated if you could provide your advice at your earliest convenience.

Yours sincerely,

The Honourable John Manley, P.C., M.P.
The Honourable Mauriziào Bevilacqua, P.C., M.P.

Annex B

Bank and Life Insurance Structure in Canada and Selected Other Industrialized Countries^[2]

Canada

• Five large banks with nationwide branch and ATM networks dominate Canada's banking sector. National Bank of Canada is the sixth largest bank with operations centred in Quebec. HSBC Bank of Canada, a Canadian subsidiary of UK-based HSBC Holdings plc, has grown considerably in the past few years and has become the seventh largest bank, with operations concentrated in western Canada.

• Credit unions provide similar deposit-taking and lending functions as banks, and are increasingly active in the provision of wealth management services. Because they are owned and controlled by their members, credit unions are generally local in nature. As of 2001 there were nearly 2,000 credit unions and caisses populaires in Canada. They have significant operations in several areas of Canada, especially in Quebec and the western provinces.

• Canada's five largest bank concentration ratio is one of the highest in the world, with approximately 77 per cent of total deposits held by the top five banks in 1999.^[3]

• The concentration ratio for the life insurance sector is also one of the highest in the world, with the top five life insurance companies accounting for about 73 per cent of consolidated assets in 1999.^[4]

Australia

• Australia's banking sector is similar to Canada's in that it has four dominant large banks with nationwide branch and ATM networks. The four banks compete with some mid-sized regional banks.

• Australia's four large banks have been built up previously through consolidation.

• In 1997 Australia lifted its restriction on cross pillar mergers involving its largest banks and insurance companies. At the same time, it announced that mergers between the four largest banks were not permitted, as a matter of policy.

• Australia has experienced some consolidation recently involving large banks and smaller or mid-sized regional banks.

• Australia's five largest bank concentration ratio was close to 74 per cent in 1999.

• The concentration ratio for the top five life insurance companies was approximately 60 per cent in 1999.

United Kingdom

• Four large domestic international banks dominate the banking industry in the UK.

• In 2001 the UK government did not allow Lloyds TSB and Abbey National, at the time the UK's third and fifth largest banks, to merge.

• The five largest bank concentration ratio in the UK in 1998 was 35 per cent.

• The concentration ratio for the top five life insurance companies was 39 per cent in 1999.

Netherlands

• In 1988 a ban on mergers of major banks with another bank of significant size was lifted in the Netherlands.

• Three large mergers followed:

• in 1989 the fourth and fifth largest banks merged to form NMB-Postbank;

• in 1990 the two largest banks merged to form ABN-AMRO; and

• in 1991 NMB-Postbank (then the third largest bank) merged with the largest
  Dutch insurance company to form ING.

• In 1999 the Netherlands' five largest bank concentration ratio was 82 per cent.

• The concentration ratio for the top five life insurance companies was approximately 58 per cent in 1999.

United States

• The United States has thousands of banks. This reflects the previous regulatory regime that limited interstate banking.

• Currently the United States does have a few very large national banks, and the process of consolidation is continuing.

• In 1998 the U.S. lifted the restriction on cross pillar mergers.

• Unlike other countries, in the context of a merger, the U.S. has statutory limits on the size of the deposit base for a bank, which stipulate that a merged entity cannot hold more than 10 per cent of nationally insured deposits, and more than 30 per cent in a particular state (this criterion varies somewhat by state).

•  The U.S. five largest bank concentration ratio was 26 per cent in 1999.

• The concentration ratio for the top five life insurance companies was around 25 per cent in 1999.

¹ Under the Government's ownership policy, banks and demutualized insurance companies with over $5 billion in equity must be widely held. Banks and demutualized insurers with under $5 billion can be closely held. Demutualized insurers and banks with equity between $1 billion and $5 billion will be required to have a 35-per-cent public float. Demutualized insurers and banks under $1 billion face no ownership restrictions.[return]

² To permit cross-country comparisons, data on concentration for each country was sourced from the Group of Ten Report on Consolidation in the Financial Sector, January 2001 (the report is available on the Web sites of the Bank for International Settlements, International Monetary Fund and Organisation for Economic Co-operation and Development). The concentration ratios are based on total deposits for banks and total consolidated assets for insurance companies.[return]

³ The five largest bank concentration ratio, as measured using retail deposits only for 2001, is 65 per cent.[return]

⁴ The five largest insurance company concentration ratio, as measured using domestic assets only for 2001, is 65 per cent.[return]