The Canadian government’s stance on bank mergers has been based almost exclusively on political considerations and, unfortunately, not on what consti- tutes the appropriate policy. Characterizing banks solely as providers of retail banking services to individuals and small- and medium-sized businesses, and ignoring their role in capital formation and as intermediaries in the financing of our largest, most successful national and international business enterprises, has led to endlessly deferred decisions on this issue, with serious consequences for our country.

Jean Chrétien was well known for not launching ambitious policy intitiatives when there was no overwhelming popular demand for them. Instead of managing public opinion about bank mergers when they were first proposed in 1998, Liberal MP Tony Ianno was sent out with a delega- tion of Commons members to ask the redundant question of Canadians, ”œDo you like the banks?” It would be a strange thing indeed if the ability to initiate business com- binations were turned into a popularity contest.

The result has been a drawn-out process of introspec- tion that resembles what happens when one asks a teenager to clean up his room. One excuse after another is advanced, all seemingly well-founded, but adding up to an endless goat rodeo of procrastination.

First, we had to wait for the MacKay Report in September 1998. Failure to follow the timetable for this report, commissioned before the announcement of the first merg- er, was the ostensible reason then finance minister Martin was so upset at Royal Bank of Canada (RBC) and Bank of Montreal (BMO) for ”œjump- ing the gun” by announcing their proposed transaction before the gov- ernment could demonstrate leader- ship on the issue. Of course, there was also the problem of not informing the finance minister, Paul Martin, about the planned announcement so he could prepare his reaction before it entered the public domain.

Then, after that merger and the pro- posed TD-CIBC union were blocked in December 1998, we had a policy White Paper in June 1999, new banking legislation in 2001, a Senate Banking Committee report in December 2002, a House Finance Committee study in March 2003, a public consultation in December 2003, and an 18-month moratorium placed on announcements until September 2004, pending answers to three final policy questions from the Department of Finance in June. The teenager’s room is still messy!

The implications of this dilatory route to a definitive policy are grave.

Canada’s major banks have grown dramatically, as measured by capital, since 1990, but, relatively, Canada’s presence has diminished. We had three banks among the global top 50 banks in 1990, none in 2003. Whereas Royal Bank of Canada was number 38 in 1990, with CIBC num- ber 40 and TD Bank number 49, by 2003 Royal had dropped to 51st, and Scotiabank was in 54th place, with BMO at 62nd. CIBC had become 65th in the global bank size sweep- stakes, and TD was 70th. By con- trast, foreign competitors, including Citibank, J.P. Morgan Chase, Bank of America, HSBC and Mizuho have grown exponentially through con- solidation.

There have been no transforma- tional mergers among Canadian banks since the combinations of the Bank of Toronto with the Dominion Bank of Canada in 1955 and the Canadian Bank of Commerce with Imperial Bank of Canada in 1961. In 1985, we lost a number of smaller Schedule A Cana- dian banks as the result of the regulator-imposed clo- sures of Canadian Com- mercial Bank and Northland Bank, followed soon after by the absorp- tion of the Bank of British Columbia, Mercantile Bank of Canada and Con- tinental Bank into other institutions. Other banks disappeared from the scene, with the merger of Bank of Alberta and Western and Pacific Bank to form Canadian Western Bank, and the absorption of several exiting Schedule B banks into HSBC Bank Canada.

In the wake of the dramatic events of 1985, Canada led the way in acknowledging the evolution of capi- tal markets by opening the ownership of investment dealers to the banks and permitting banks to acquire the remaining large trust companies, some of them in difficult straits.

But the result of placing a moratori- um on large bank mergers in the late 1990s has been to channel the US ambitions of Canadian banking insti- tutions into a variety of investments which were, by and large, sub-optimal. Since BMO bought Harris Bank of Chicago in 1984, it has made only small add-on acquisitions. CIBC made a bet on Oppenheimer, and a direct investment in Amicus, neither of which has worked out very well. Royal Bank bought a great, tiny bank called Centura, a couple of small investment banks and a mortgage broker. None of these actually give Royal the ability to execute on large financings in the US.

What the banks need is the capital base that would result from a combi- nation of any two of the large Canadian banks to make more mean- ingful acquisitions south of the border without betting the bank.

Why is this so important? In 2003, foreign-owned investment banks had 43.4 percent of the fees paid to the street by Canadian companies on those transactions for which the inter- national firms compete (i.e. excluding income trusts, domestic equity and debt and small domestic merger and acquistion (M&A) deals). This is an astoninshing phenomenon, consider- ing the size of the Canadian opera- tions of international investment banks, and results from the fact that Canadian lenders are really not able to follow our national champion corpo- rations when, to our enthusiastic approval, they grow beyond our bor- ders and become major international names. Our policy condemns our banks to wave goodbye to their clients at the border, while we encourage the CNs, Nortels, Alcans, JDS Uniphases, Incos and others to expand aggressive- ly in foreign markets.

In turn, this forces our CEOs to discuss their financing plans in US and other foreign bank head offices. Rather than taking their lead advice from Gord Nixon of RBC or Rick Waugh of ScotiaBank or Tony Comper of BMO, they are moving their head offices or executive offices to the US in order to be clos- er to financial decision-making (IPSCO, Moore-Wallace, Thompson Corp., Laidlaw, Nova Chemicals, etc.) or selecting CEOs who reside in the US (Alcan, CN Rail, Cott, Glamis Gold, etc.). This works to deprive Canada of head office-type jobs for our next generation, not only in the banking sector, but in all of the busi- nesses which need financing from banks capable of executing on a global level.

What is the alternative? A merged Canadian institution would have a market capitalization of over $50 billion US. It could comfortably buy Bank of New York, National City, Sun Trust, PNC, KeyCorp, South Trust or M&T Corp., all excellent institu- tions, among others. Or, they could choose to buy Lehman Brothers or Bear Stearns to achieve critical mass in investment banking. The execu- tion of transactions would still be in world markets, but the advice would be given and the plan developed in Toronto and not New York.

The implications of viewing financial markets from a Canadian perspective are both concrete ”” in employment, retention of head offices and retarding the hollowing out of our corporate sector ”” and intangible, resulting from Canadian considerations being at the forefront of the decision-making. Bankers who have been involved in this process in other countries will confirm that hav- ing a proponent of national interest does make a difference.

Holland, with one-half of our population, and Switzerland, with one-quarter of our population, have figured this out. Holland has four banks larger than our biggest bank, the Royal, (ING, ABN AMRO, Rabobank and Fortis) and Switerland has two banks bigger than the Royal (UBS and Credit Suisse). What do they know that we don’t?

It may well be that our banks have not treated the political side of this issue with the care they have devoted to the policy side. In the 1998 round, the bank leaders empha- sized synergies and cost savings, including those involving branch closures and employee layoffs. The government has countered by adding to the statutory requirements of approval by the prudential regulator, OSFI (the Office of the Superintendent of Financial Institutions), and the competition regulator (the Competi- tion Bureau), a public interest test in virtue of which merging institutions would have to eschew some of the tra- ditional sources of accretive financial results in favour of selling, not closing, branches (in clusters capable of being managed by existing supervisory staff) and relying more on attrition to shrink their staffs.

There remain the three questions bequeathed to us by former finance minister John Manley after a purport- ed 2002 round of mergers, one between two banks and one a ”œcross- pillar” merger between a bank and an insurance company, were called off, reportedly on direct orders from the PMO in October of that year. Will the government allow one or two bank mergers, and, if two, should the gov- ernment set up a 60-day window for merger proposals in order to avoid first-mover advantage? Should the government permit a cross-pillar merger in order to avoid the disap- pearance of a bank?

The right answer is that the gov- ernment does itself no favours by maximizing pent-up merger demand through continued policy contem- plation. The government was on the right track in the latest revision to the Bank Act (adopted in 2001) when it provided for a model for the delivery of banking services, which was more diverse than a handful of monolithic domestic banks and a constrained group of foreign bank subsidiaries. In that statute, provi- sion was made for access by foreign institutions to operate as branches in Canada instead of through the Schedule B subsidiaries required up to that time. Also, the enact- ment made it easier for qualified new entrants to start up new Canadian banks by low- ering the capital requirement for a new bank to $5 million from $10 million.

The government should not try to micromanage the outcomes or pick winners and losers. They should let the managements, boards of directors and shareholders of the institutions, as in every other business, determine when and whether to propose mergers sub- ject to known and clear regulatory cri- teria. The government should also level with the banks. If it thinks that some of them are too big to be permitted to merge with any partner, it should put them out of their misery by telling them and letting them get on with life.

In particular, the concept of a cross-pillar merger, tempting to the politicians on the superficial level because it does not result in the ”œdis- appearance” of either merger part- ner, holds great danger for the government on the policy front. Because two banks when merged become a single entity, such a union does not raise issues of ownership restrictions. But an insurance compa- ny and a bank can only ”œmerge” by one acquiring the other, or both being owned by a holding company.

Policy-makers have long stated that the limit on ownership of voting shares permitted to any indi- vidual or entity (becoming 20 per- cent under the provisions of the new legislation) can be satified if the top company in the chain is widely held and publicly traded and no share- holder exceeds the allowable hold- ing. But we have never bitten the bullet about whether such a top company can be outside Canada. According to NAFTA, our US and Mexican partners are entitled to ”œnational treatment” in such mat ters, but that could result in all of our banks and de-mutualized insur- ance companies disappearing into widely held American entities. A cross-pillar merger would set up the granddaddy of all trade disputes, which we very well might lose.

Let us hope that the government provides its answers as promised by June 30. The government has never acknowledged what everyone knows, namely, that the dates of June 30 and September 30 were cho- sen to coincide with the then- conventional wisdom about the electoral calendar. It would be a shame to once again postpone the overdue by allowing a deferred elec- tion to cause yet more delay.

Banks should use their hard-learned sophistication about what they didn’t do right last time to maximize the con- ditions for approval. They should be lobbying individual MPs, consumer groups, observers and commentators and even their fellow members of the business community in addition to Ottawa insiders and decision-makers.

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