Banking, says Robert MacIntosh, president of the Toronto-based Canadian Bankers’ Association, used to be a simple business. Fifty years ago the chartered banks basically offered the public only three services: savings accounts, chequing accounts and demand loans. But over the years, encouraged by more liberal rules under oncea-decade amendments to the federal Bank Act, the major banks have introduced a multitude of savings and chequing accounts, and a bundle of such new financial products as term deposits, investment certificates, mortgages and various types of retirement savings plans. Now the banks are embarking on another great leap forward. Within a few years, says Macintosh, customers may be able to buy house, car or life insurance from their corner bank. And soon they will be able to get advice from the banks on buying and selling shares on the stock markets.
That new era in Canadian banking began officially on June 30, the socalled Big Bang day.
Effective that day, Ontario regulations that prohibited banks from owning securities firms were lifted, and Ottawa plans to respond by amending the Bank Act. Since the Big Bang, three marriages between bankers and brokers have been announced. In the next few months other legislative barriers separating banks, trust companies and the insurance industry may also come tumbling down. Besides deregulation, another fundamental change is transforming a business that has traditionally earned its profits on
the spreads between interest paid to depositors and that collected from loans. Over the past five years fees for dozens of services—from writing cheques to packaging corporate loans— have become the fastest-growing source of bank revenue.
But even as the chartered banks took steps to make the most of deregulation, they also faced an order from Ottawa that will result in huge quarterly losses and restrict their ability to grow. To protect shareholders and customers, Ottawa ordered the banks to increase loan-loss reserves from under 11 per cent to at least 30 per cent of the $24.4 billion loaned to 34 Third World countries, mainly during the 1970s.
Prior to the order, the six largest banks—Royal Bank, Bank of Montreal ( B of M ), Toronto-Dominion Bank (TD), Canadian Imperial Bank of Commerce (CIBC), Bank of Nova Scotia (BNS) and the National Bank of Canada—had set aside a total of $3.1 billion 2 against potential losses g on those loans. John lt; McDonald, senior bank = analyst with the Toronto
1 investment firm Moss
2 Lawson & Co. Ltd., said « that the banks will 2 have to set aside a furI ther $5.7 billion in reserves to comply with the order.
As a result, the banks will report “the largest losses in the history of Canadian banking,” said McDonald. Last week the B of M disclosed that it will be adding $753 million after tax to its loan-loss provisions. The TD said that it will increase its reserves by $736 million and predicted a net loss of $333 million for the quarter. The CIBC announced an $850-million increase in its
reserves, which will cut thirdquarter profits by $450 million after tax. The other two banks have not revealed how Ottawa’s order will affect them. In any case, taxpayers will bear part of the banks’ costs. One analyst, who asked not to be named, noted that any losses incurred by the banks can be used to reduce tax payable.
Senior bank officials, meanwhile, tried to play down the impact of the losses, TD president Robert Korthals told Maclean’s that bank stocks have been trading at a discount for some time because most investors were well aware of the problems with the Third World loans. He added that he does not
expect any significant drop in share prices due to last week’s announcement. “I think the banks will explore ways to reduce the percentage of assets that are in those loans,” he said. “But they will be with us for the whole decade.”
So far, the most dramatic result of deregulation has been the bank-broker mergers. First, Toronto-based Wood Gundy Inc. announced that First Chicago Corp. had acquired a 35-per-cent ownership interest, as a passive investment, for $271 million. Next, the CIBC and Gordon Capital Corp. announced that they were forming a new merchant bank called Gordon Investment
Corp. Then, two weeks ago the B of M announced that it would purchase up to 75 per cent of Toronto-based Nesbitt Thomson Deacon Inc. for $290 million. The Royal Bank, which unsuccessfully pursued Wood Gundy, is still keen to enter the investment banking business. Said Royal chairman Allan Taylor in an interview: “We’re certainly
going to be in investment banking.”
On the other hand, the TD and the BNS say they hope to expand their existing brokerage services rather than buying established firms. The TD launched its Greenline discount brokerage service 3V2 years ago. TD clients can buy or sell stocks through Greenline accounts, but they do not receive any investment advice from the bank—enabling TD to charge lower transaction fees than conventional brokers. Earlier this year the TD took steps to improve the service by acquiring seats on the Toronto, Vancouver and Montreal stock exchanges for a total of $235,000. The BNS set up a similar discount brokerage in the province of Quebec last November.
Financial analysts and other observers are divided on the merits of the bank-broker ventures. Terry Shaunessy, bank analyst with Merrill Lynch Canada Inc., said that the deals have not substantially changed Canada’s financial community. If a major international broker had bought a large Canadian firm, it would mean stiff new competition for existing firms. It would also extend the Canadian firm’s clout in international markets. But others contend that the B of M /Nesbitt Thomson deal could lead to a major innovation in retail banking. Toronto investment adviser Thomas Delaney said he expects the bank will set up computer links between its branches and Nesbitt Thomson offices coast to coast. B of M customers would then have access to a full range of brokerage services at their local branch. Indeed, said Nesbitt Thom-
son president Brian Steck: “The bank may wish to offer investment advice and brokerage services to its clients.”
Bankers say that they are looking for new financial services to offer through their branches. “There will be an everbroadening list of services offered,” said the Royal’s Taylor. “Eventually insurance will be part of it.” Currently, the banks are pressuring Ottawa for the right to sell insurance through their branches. CBA president Macintosh, the chief lobbyist for the banking industry, said the banks could reduce the price of insurance by eliminating agents. “The banks would like to get into the distribution of retail products such as fire insurance on your house and car insurance, probably simple forms of life insurance,” said Macintosh.
With fundamental changes sweeping the lending business, the banks had to lobby for deregulation and expanded services, said Taylor. Banks have been losing corporate clients to less-regulated competitors who can set up a loan at less than bank rates and then sell it to a pension fund or other large institutional investors. Federal regulations make bank loans more expensive, added the TD’S Korthals. Banks must maintain unproductive cash reserves as a percentage of total loans outstanding. Canada Deposit Insurance Corp. premiums are also rising due to the bank and trust company failures of the past two years. As well, the banks are subject to limits on the total volume of loans outstanding by imposing a ceiling related to the bank’s total capital base. When a bank reaches its lending ceiling, it must raise new capital, usually through a stock issue.
Although bankers say that they have little choice but to rely on corporate and retail fees, critics question the new user-pay policies, particularly at the branch level. Montreal-based investment counsellor Stephen Jarislowsky said that the service fees are nothing more than a tax on the public to cover bad loans to Third World countries. “The government wants the banks to suck that area dry rather than have the banks go bust or have to be assisted,” said Jarislowsky. Analysts also question whether the banks should be selling the public such uninsured speculative financial products as stocks. For his part, Toronto financial adviser Delaney says that he has many misgivings about the new rules. “In my view,” said Delaney, “consumers are going to be a hell of a lot more vulnerable as a result of deregulation.” At the very least, they will witness some major changes in the chartered banks during the months to come.
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