Alarm in the Banks
The $9-million investment decision was typical of dozens made every business day in Canada—all-important to the investor, all but routine for the country’s six biggest banks. But the decision’s timing—and the forces that helped the municipal administrators of Burnaby, B.C., to reach it—was a far-from-routine situation: Canada’s multibillion-dollar banking industry was in the throes of a crisis in confidence, with potentially far-reaching financial and political consequences. With the Edmontonbased Canadian Commercial Bank and the Calgary-based Northland Bank in liquidation and rumors of difficulties at other small banks, Burnaby’s finance officials were exercising caution They had already risked $3 million—on deposit at the CCB when it collapsed on Sept. 1—and they decided to shift $9 million from the relatively small but sound Bank of British Columbia (assets: $3.3 billion) to the socalled “Big Six” (combined assets: $375.4 billion). Said Burnaby finance director Howard Karris: “As soon as the CCB collapsed we reassessed our investment guidelines.”
Safety: By choosing to spread its funds among the Big Six, Burnaby civic leaders were making an assumption shared by thousands of everyday savers: there is increased safety in larger-sized banks In descending order of size, those institutions are the Royal Bank of Canada. the Bank of Montreal, the Canadian Imperial Bank of Commerce, the Bank of Nova Scotia, the Toronto-Dominion Bank and the National Bank of Canada. At the same time, the Vancouver suburb became part of what has emerged as a sustained seven-month-long run on Canada’s smaller banks.
Last week the run began to moderate but it left political controversy in its wake. For its part, the Bank of British Columbia appeared able to withstand the loss of Burnaby and other depositors —possibly because of cash transfusions from the Big Six (page 58). Said Vancouver’s Peter Stafford, secretary of the Bank of B.C.: “We have the same level of deposits, or slightly more, as before [the CCB failure]. Where they are coming from we are not saying.” Emergency: Still, ever since the federal government announced on March 24 that the now-defunct CCB required $255 million in emergency assistance, there has been a steady outflow of funds—mainly belonging to institutions and corporations — from Canada’s smaller banks. The Bank of Canada—the federal agency that oversees the banking industry —has tried to prevent the outflow—and restore confidence—by pumping an unprecedented total of $2.35 billion directly into the banking system. And a chorus of Big Six executives, business leaders, investment analysts and members of Prime Minister Brian Mulroney’s government have declared that the country’s banking system remains one of the world’s most secure.
But the recent collapse of the two Alberta banks—the first Canadian banks to fail since the badly mismanaged Home Bank of Canada abruptly closed its 74 branches in 1923 following a series of disastrous real estate investments—was followed in October by the forced merger of the faltering Mercantile Bank of Canada, with assets of $4.4 billion, and the National Bank. And despite efforts on the the part of the government and the Big Six to ease concerns that there might be further failures, some investors continued to be wary. Acknowledged Bank of Canada Gov. Gerald Bouey, in an otherwise optimistic interview with Maclean's last week: “There has been damage to confidence in the smaller banks.”
Intense: Efforts to repair that damage and to reassure Canadians that money in the bank is safer than money in a mattress continued last week. The bank under pressure was the Continental Bank of Canada, with assets of $6.2 billion the country’s seventh-largest. Officials acknowledged that it had received help from the Bank of Canada because of a liquidity squeeze. But Maclean's has learned that after a week of intense lobbying, the bank had also gained support from the financial community.
But before Mr. Justice Willard Zebedee Estey’s royal commission of inquiry into the Alberta bank failures, which resumed hearings in Ottawa last week, there were further revelations of disagreement behind the scenes over how to handle the bank crisis. Estey is the Supreme Court of Canada judge selected by Mulroney to investigate the circumstances surrounding the decline and fall of the CCB and Northland bank. And evidence placed before Estey revealed a sharp philosophical disagreement between Mulroney and Barbara McDougall, the minister of state for finance. According to documents tabled by the office of the Inspector General of Banks, McDougall favored closing the CCB last March, but Mulroney—supported by Finance Minister Michael Wilson—insisted on a rescue effort. Bouey agreed with Mulroney. The central banker told Maclean’s: “I am in favor of saving banks if it is at all possible and at reasonable cost.”
Attack: Other evidence showed that McDougall had argued against the government’s eventual decision—which she subsequently defended in the Commons —to augment the Canada Deposit Insurance Corp.’s (CDIC) $60,000-per-depositor insurance coverage. The disclosure of the McDougall-Mulroney differences led New Democratic Party Leader Ed Broadbent to call for McDougall’s resignation. Opposition MPS were expected to redouble their attack on the government’s handling of the bank crisis in the light of the latest disclosures. But it was evident that taxpayers have already had to cover losses incurred by incompetent bankers and imprudent investors.
One outcome of the current political debate—and the various inquiries into the run on the banks—seemed certain to be the introduction of more stringent regulations governing bank audits and revised powers for the office of inspector general of banks. As well, there were likely to be more strictly defined responsibilities of those in business who traditionally monitor banks—outside auditors and directors.
Certainly, the crisis of confidence has taken its toll—and left senior management of the minor banks reluctant even to acknowledge receiving Bank of Canada support. Said Conservative MP Donald Blenkarn, chairman of the Commons finance committee: “There is a perception that if a bank gets into a liquidity crunch and the Bank of Canada comes to its assistance, it is almost like announcing it has AIDS.” Despite government efforts to save them, the CCB and Northland foundered under the weight of uncollectible loans and wholesale withdrawals.
Tragedy: And although the Mulroney government pledged to protect all depositors, including those whose deposits exceeded the $60,000 limit, for a projected $1.2-billion cost to the federal treasury—their collapse was a major setback to some Western Canadians (page 52). Many small-businessmen in the West wanted the regional banks to provide a strong alternative to the centrally based Big Six. Said William Ketcheson, co-owner of Calgary’s Petrowest Petroleum Ltd., a former Northland customer: “The bank [Northland] fulfilled a role out here by helping small-businessmen whom the major banks were pulling away from. Regional banking is threatened, and that is a tragedy.”
In addition to the two outright failures, the confidence crisis forced the fundamentally sound Mercantile Bank to accept an October merger proposal from the National Bank of Canada, with assets of $19.25 billion. Money-market investors began to distrust Mercantile’s ability to honor its own promissory notes after the CCB crisis developed, despite the fact that the bank was 24-per-cent owned by the giant Rockefeller-controlled CitiBank NA of New York. Mercantile’s resulting cash squeeze threatened its ability to continue day-to-day operations and—before the National merger was arranged—it received an estimated $300 million in emergency deposits from the Big Six.
Like most Canadian banks, Mercantile was heavily exposed in Western Canadian real estate deals—but it lacked a broad nationwide deposit base to help sustain cash flow. And in its 1984 annual report it revealed that it was carrying a high proportion of nonperforming loans on which no interest had been paid for at least three months—half of them in real estate. Said a disappointed Robert Davidson, chairman of Mercantile, in an interview with Maclean’s last week: “We were not recession-proof.” Added Merrill Lynch Canada Inc. banking analyst Terry Shaunessey: “The Mercantile was caught in the cross fire.”
For its part, the National had been interested in the Mercantile for at least a year. In fact, the two banks held informal discussions in the fall of 1984 about a possible merger. And when the New York investment firm of Salomon Brothers invited bids for Mercantile last month, National Bank executives worked through the Canadian Thanksgiving weekend to prepare their offer. With National chairman Michel Belanger in Peking on a business trip, it fell to president Gilles Mercure, 59, to hand-deliver National’s bid to Toronto before the 11 a.m., Oct. 15 deadline. When Mercure’s flight was delayed in Montreal there was a brief flurry of concern, and the Montreal bank considered sending its offer on a facsimile transmitting machine from head office. But Mercure reached Toronto with the formal bid with 20 minutes to spare. The following day National learned it had been chosen from among several Canadian bidders. According to National executives the outcome pleased the Bank of Canada and other government officials. Said vice-president Edward Lyssan: “As far as public perception is concerned, it is better that a smaller bank got it. We are still number 6.”
Problems: It was the second major advance by the National. In 1979 it merged with the Quebec-based Banque Provinciale, making it the sixth-largest. After five years of consolidation, during which it reduced its number of branches to the current 571 from roughly 850, the National was ready to expand again when the Mercantile opportunity arose. Lyssan said that his bank was not concerned that it would face the same problems which the Mercantile encountered in the past few months, adding, “We are a bigger bank now, which makes liquidity problems that much more remote.” Although the National still has no plans to enter the retail banking market west of Ontario, the Mercantile merger is expected to establish the National’s corporate-lending profile in the West. Said an exultant Lyssan: “We have put our expansion plans ahead by two years.”
For its part, the Continental Bank of Canada appeared to have restored confidence in its operations last week. Like Mercantile, Continental also faced a liquidity squeeze which caused serious concern in the Canadian financial community (page 50). But Maclean’s has learned that after drawing support from the Bank of Canada, Continental began a concerted campaign among professional Bay Street money managers to reinforce the bank’s reputation.
Crisis: At week’s end, the campaign appeared to be succeeding. Said R.H. Lavers, vice-president of Toronto investment dealer Midland Doherty Ltd.: “I have every confidence in the Continental Bank. Its assets and management are very sound, and we will do our best to market their deposits.” Indeed, according to Lavers, “all the minor banks are now trying to reawaken institutional interest in their deposits and acceptances. It is a normal thing, now that the crisis is over.”
NDP finance critic Nelson Riis also praised efforts by the Big Six to restore overall confidence in the system. Said Riis: “I think the banking crisis is over.
Frankly, people have more confidence in the Royal Bank than the central bank.” To help foster the idea that the system was sound, on the banks’ suggestion, the Big Six dispatched teams of special auditors to help the inspector general of banks evaluate the assets and liabilities of the smaller Canadian-owned banks. The roving inspection teams—which delivered approved audits for such banks as the Mercantile and Continental —were at least partly a gesture aimed at reassuring the Canadian and international money markets. Although the Big Six were widely regarded as net winners in the shakeout, there were strong indications that they grew increasingly concerned about the industry’s overall image as the crisis wore on. In fact, Royal Bank chairman Rowland Frazee, in an Oct. 17 speech at Acadia University in Wolfville, N.S., criticized what he called the “malevolence and ignorance” on the part of some of the banking system’s critics.
Frazee went on to list five “persistent myths” about Canada’s banking system, which, he declared, 75 per cent of the people regarded favorably. According to Frazee—and contrary to mythology—banks do not represent shadowy interests pulling the nation’s financial strings. Nor do they lend their own funds and extend loans only to people who do not need the money. He said it is also untrue that banks make huge profits without paying taxes, adding, “The fifth and final myth is that we never suffer losses, and that one, especially, is not true.”
Indeed, the losses can be staggering.
From 1980 to 1984 Canadian-owned banks wrote off $9.6 billion in bad loans. And the banking industry currently carries roughly $10 billion in nonperforming loans. But the banks —particularly the five biggest—are so strong that most analysts regard potential losses as manageable. In the case of the failed Alberta banks—the CCB and the Northland—the problem of nonperforming loans was compounded by an inability to attract new deposits, particularly during the severe recession that persisted in the province after it eased elsewhere in the country.
Gleaming: The Big Six had no similar difficulties. With almost 7,000 branches across the country, nearly 150,000 employees and assets of roughly $375 billion, Canada’s chartered banks constantly attract new business—and new critics. The banks are at once highly visible and dominating forces in everyday Canadian life, just as their gleaming office buildings tower over the nation’s cities and their board members collectively wield vast financial influence. A Canadian bank is usually as near as the next intersection—appropriately convenient for a nation of savers.
Indeed, the chartered banks contain roughly six savings accounts—each containing more than $3,400—for every five members of the Canadian population. As well, bank managers—with their patented exaltation of the virtues of prudence and thrift—traditionally have exercised substantial, if sober-sided, influence within local communities. McDougall, for one, saluted the Canadian banking tradition. In response to a question by Liberal finance critic Raymond Garneau (Laval-des-Rapides) she told the Commons that the Canadian system “has served us well for a hundred years, and it is continuing to do so.”
Still, the shaken confidence in the banking system raised the question: did the major banks still merit their image as prudent, cautious and skilfully managed institutions? Most members of the business community said yes. Declared Thomas d’Aquino, president of the Business Council on National Issues: “There might be fear on the streets of Moose Jaw—I don’t know, I’m not there—but I can tell you categorically that the leaders of the Canadian business community have confidence in the system.” Added Bernard Ghert, president of real estate giant Cadillac Fairview Corp. and a former professor of finance at the University of British Columbia: “The major banks are strong enough to deal with any loss of confidence, and left to themselves they will. There are no more responsible people than the chairmen of some of the major banks.”
Failed: By coincidence, the chief executives of the Big Six were in Ottawa in mid-September to appear before the Commons finance committee. Most of the top bankers, including Toronto-Dominion chairman Richard Thomson, said they were reluctant to participate in the government’s attempt to bail out the CCB. Said Thomson: “The bank should have failed at the time of the March weekend.”
Indeed, Canadian bankers’ reputation for circumspection may have contributed to the origins of the crisis. Said the NDP’S Riis, referring to the failures: “People have become aware that all bankers are not prudent. And people have realized for the first time that the inspector general did not know what was going on.” Added Robin Cornwell, a banking analyst at Gordon Capital Corp. and a special adviser to the House of Commons banking committee in 1982: “You have to regulate banks, and I would be strongly critical of the regulatory system. Banks are not scrutinized strongly enough.”
Evidence before the Estey commission showed that Kennett’s office relied principally upon reports by the CCB’s outside auditors to monitor its health. But the auditors, in turn, relied upon information provided by the bank’s management to prepare their reports.
If critical information were deliberately withheld by the bank during an outside audit, Canadians would have no effective way of knowing the bank’s real condition. Said Bouey, during testimony last month before a Senate banking committee inquiry into the CCB collapse: “It does look to me as if there has been a serious breakdown somehow or other in the inspection system on this occasion.”
Surprise: Despite the fact that reports of trouble at the CCB had circulated within the financial community for more than two years, the government-organized March rescue attempt caught some members of the accounting and banking professions —and many politicians—by surprise. In fact, Kennett was out of the country—holidaying in the Caribbean. For his part, Bouey, who in 1983 took the unprecedented step of personally telephoning a Toronto newspaper, The Globe and Mail, to try to counter rumors that the CCB was in difficulty, told the Senate committee: “At no time had anyone ever told me—and I include the large banks—that the [inspection] system was not working.”
In his interview last week with Maclean ’s Ottawa correspondent Paul Gessell, Bouey said that the inspections of the smaller chartered banks, which were carried out this fall by representatives of the Big Six, should help restore public confidence. Added Bouey: “I wish people would shift their attention to what has recently been done in the system. Now these inspections were never carried out before. The system has changed already.” Bouey said that, on the basis of the inspections, the Bank of Canada felt confident enough about the smaller Canadian-owned chartered banks “to look after any liquidity needs.” Added Bouey: “I see no weakness in the system at the moment—none at all. I think we have had the inspections that show there is no weakness.”
Damaging: At the height of the crisis the Mulroney government took steps to protect the smaller banks from the potentially devastating effects of gossip in the financial community. To that end it even briefed the opposition on developments. One example: McDougall met Liberal Leader John Turner and the NDP’S Broadbent on Oct. 10 to discuss the Mercantile Bank’s rapidly worsening liquidity squeeze. At the same time, sources said, the government urged the opposition parties not to ask questions in the Commons that could be damaging to banks. Said one government insider: “We were concerned about the possibility that questions about Mercantile would lead to questions about Continental, or two or three others. Once you start these things, who knows where they will stop?” But opposition MPs decided to continue their attack on the government’s handling of the crisis. Said the NDP’S Riis: “We wanted to ensure that the questions we asked would not erode public confidence in banks.”
Linger: At week’s end, the combined “damage-control” efforts—by the Big Six, the Bank of Canada, the threatened smaller banks, and the business community-seemed to have become increasingly effective. And the banking community began to look forward to a period of renewed stability, following months of uncertainty and confusion. But the aftereffects of the crisis were almost certain to linger in the public consciousness, if only because the Estey inquiry was still in its early stages and further politically controversial details of the Mulroney government’s performance are likely to emerge.
As well, federal politicians faced the prospect of drafting and enacting new regulatory provisions designed to control banks in a modern economic environment. Said economist Arthur Donner, a consultant to Research Securities of Canada Ltd.: “The banking system has changed dramatically in the past 10 years, but the regulatory system has stayed the same. It must be overhauled.”
-ROBERT MILLER with PAUL GESSELL in Ottawa, BRUCE WALLACE in Montreal, JANE O’HARA in Vancouver, LENNY GLYNN in New York and SANDY FIFE, ANN WALMSLEY, MICHAEL SALTER and MARC CLARK in Toronto