Frustrated bankers view a planned new law on mergers as political punishment from Ottawa
The rift simmers like an Ozarks feud. There is no doubt that Canadas big banks started their quarrel with Ottawa, insouciantly announcing mergers before a merger policy existed. But two years later, the banks cannot placate their stillresentful regulators. Ottawa is now drafting legislation that will impose a complicated approval process on any merger among the Big Five banks—and which will forbid the banks from joining with the two largest demutualized life insurance firms. Any bank pairing would require public hearings on virtually every aspect of the deal. Canadas banks, tumbling in global status, are seething with frustration. “We are in a highly competitive game and we are hamstrung in our ability to deal with it,” says Royal Bank CEO John Cleghorn. “Two years ago, we were put in the penalty box. What’s the time limit on a penalty? Do you want to wreck a whole industry because of what happened then?”
The standoff is critical because the financial services sector plays an enormously pivotal role in the Canadian economy. It employs more than half a million Canadians, pays more than $9 billion in annual taxes to all levels of government, exports nearly $50 billion in services— and represents five per cent of Canadas gross domestic product. Its stability and strength are crucial to virtually every other aspect of the economy. From the banks’ point of view, Ottawa is caught in a time warp—while their world has changed with disconcerting speed.
Since 1998, there have been numerous multibillion-dollar mergers—with varying degrees of success—among financial institutions in Europe, the United States and Japan. The United States recently introduced laws that permit cross-ownership of banks, insurance companies and brokerage firms, and which allow them to sell each other’s products. Big is getting much bigger. “We are basically stuck in the head-
lights,” observes former Bank of Canada governor John Crow. “We have got to think more about how we can get a financial system that is going to be viable in a global economy.” Ottawa, however, has not forgotten the banks’ past highhanded behaviour. In response, it is stalling for time until it can lure more domestic—and foreign—competition into the marketplace. The banks were difficult. First, before there was a merger policy, they brazenly concluded mergers: the Bank of Montreal with the Royal Bank of Canada, and the Toronto Dominion Bank with the Canadian Imperial Bank of Commerce. Then, they complacently talked about why their plans were good for themselves, virtually ignoring consumers. By the time Finance Minister Paul Martin rejected the deals in December, 1998, Toronto-based pollster Pollara Inc. had determined that two-thirds of Canadians strongly opposed them. “The banks have done it to themselves,” says Wendy Dobson, director of the University of Toronto’s Institute for International Business. “Financial services policy in Canada is still being driven by the political backlash.”
Emotions are running high. While most bankers and politicians refuse to comment publicly about the legislation, their behind-the-scenes grumbling about each other can be vitriolic. The handful of politicians and civil servants who suspect that the bill may already be out of date will not speak out: they are hoping it will simply die on the order paper if an election is held this fall. A few brave souls on both sides are trying to make peace. “We finally realize,” insists a federal official, “that we have to start getting along.”
But peace attempts are complicated by the fact that Ottawa is torn between conflicting goals: it knows that the banks must be strong enough to battle in the world arena, but it also wants to maintain competition at home. Almost 36 per cent of the 97,000 members of the Canadian Federation of Independent Business reported last year that they were concerned about their ability to access credit—compared with 17 per cent in 1989. “Small businesses are always the ones who get nailed,” asserts CFIB president Catherine Swiff.
Meanwhile, with the emergence of international behemoths like New York City-based Citigroup Inc. last fall, Canadas big banks fret they are slipping behind. Globally, they lack the financial heít to be significant players in many internationally syndicated loan deals that would cement ties with their clients. At home, so-called single-service providers—low-overhead operations, often U.S.-based, that concentrate on one product line—are nibbling away at everything from their credit card operations to mutual fund sales.
In response, Ottawa is playing for time. It is changing bank ownership rules so that it will be easier for the Big Five to form strategic alliances with other domestic and foreign institutions, including swapping shares. The legislation, which will likely be introduced in late May, also spells out the merger process: in addition to the customary competition and prudential investigations, and the approval of the finance minister, prospective partners will be asked to present a de-
tailed “public interest impact assessment.” That would outline, in excruciating detail, the costs and benefits of the merger—along with remedies for adverse effects.
The Commons finance committee would then hold hearings on the “broad public interest” issues. A senior finance department official notes that, in 1998, the banks did not list the consumer benefits of their mergers until the public turned against them. “We are not asking them to put out proprietary data,” he told Macleans. “We are saying, ‘You should put your best case forward to the public—from the beginning—as to why this should proceed.’ ” Dobson counters that few institutions would risk such a potential ordeal. “The process is unrealistic,” she argues. “It is very unlikely that any organization would subject itself to it.”
Thwarted, their options restricted within a mature Canadian market, the big banks are increasingly looking abroad for opportunities. But, although the group’s overall earnings were up 23 per cent in the first quarter of1999-2000 and share prices have recovered from the merger debacle, they remain niche players who specialize in targeted geographic and product areas. Taken together, their capital is less than that of Citigroup alone. “International institutions seem free to merge, so that makes it even more challenging for Canadians,” says Jamie Keating, banking analyst at Merrill Lynch Canada Inc. “But they are demonstrating their ability to get around that problem by becoming extremely niche focused.” Each bank has ensured that it receives at least 30 per cent of its income from abroad. The TD owns TD Waterhouse, an international discount brokerage star. The CIBC is placing its “bank-in-a-box”—automated teller machines and instore pavilions—inside U.S. grocery stores. The Bank of Nova Scotia is focusing on the lucrative Caribbean and Latin American markets. The Royal has spent $540 million on foreign acquisitions over the past two years, including the largest independent U.S. mortgage broker. And, largely by exploiting its U.S. asset Harris Bank, the Bank of Montreal is nurturing its retail and commercial business in the underserved Chicago area. “We have moved on with what was our plan A before the mergers came along,” says CEO Tony Comper. “I am not waiting around for Godot.”
Although the earnings of the big banks are up, they remain niche players
In any event, it remains uncertain that mergers among the big banks would be good even for the companies themselves. When very large organizations blend, the new organization can become increasingly hidebound. This month, Germany’s Dresdner Bank AG abrupdy called off its planned merger with Deutsche Bank AG after a farcical failure to blend their investment banking operations. As well, based on federal competition analyses in 1998, it is equally unclear that the original merger partners would ever be allowed to link up— even under the old rules. Macleans has learned that the most acceptable mergers to Ottawa, based on an analysis of bank branch locations, credit-card operations and securities dealers, would be the BMO with Scotiabank—which heatedly
Ranking the banks
Canada’s banks are dwarfed by the world’s top 10, which have grown massively through mergers. How the assets compare (Canadian dollars):
J1 Fuji/lndustrial Bank/Dai-lchi Kangyo Japan
H Sanwa/Asahi/Tokai Japan
il Sumitomo/Sakura Japan
Deutsche Bank Germany
R Bank ofTokyo-Mitsubishi Japan
BNP Paribas France
il Citigroup U.S.
Bank of America U.S.
il USB Switzerland
HSBC Holdings Britain
n Toronto Dominion Bank (including Canada Trust) : Royal Bank of Canada CIBC
opposed the original deals—followed by Scotiabank with the CIBC. “It is going to drive John Cleghorn out of his mind,” observes an insider in a former merger deal, “that it will probably be Scotia and someone else that is merged.”
In any event, mergers are almost certainly on the back burner for at least a year. (There is a two-year moratorium on takeovers or mergers of the five demutualized life insurance companies—and Ottawa will forbid the two biggest, Sun Life Financial Services of Canada Inc. and Manulife Financial, from merging with each other.) Instead, the big banks will be granted other, perhaps equally controversial opportunities. Ownership rules, which currently prohibit any individual shareholder from holding more than 10 per cent of shares, will be changed: anyone of “fit and proper” character—including foreign institutions or individuals—will be allowed to own up to 20 per cent of the voting shares and 30 per cent of the nonvoting shares in any widely held bank. In theory, any single large foreign shareholder could wield considerable influence.
But Ottawa also wants to give the big banks a run for their money. To encourage the creation of small banks with equity of less than $ 1 billion, it will put no restrictions on ownership—and decrease capital requirements. It will allow insurance companies, securities dealers and money-market mutual hinds to join the payments system so they can create fully functional chequing accounts. And it will support the credit union movement as it tries to create a national organization to co-ordinate purchases and products. “In another generation,” says Jonathan Guss, CEO of Credit Union Central of Ontario, “you will find credit unions that want to be community banks.”
Still, for all its reluctance, Ottawa will almost certainly have I to permit mergers eventually among the large banks and life 1 insurance firms. Those institutions are already eyeing the three I smaller, recendy demutualized life insurance firms, waiting I impatiendy for the two-year moratorium on acquisition to i lapse. It is only a matter of time before the banks start wooing I each other again. Before long, Ottawa will have to take an§ other, better look at how best to protect consumers—and J Canada’s competitive edge.
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