Scotiabank's Submission in Response to Finance Canada's 2006 Review of Financial Sector Legislation:
June 1, 2005
Mr. Gerry Salembier
Director, Financial Institutions Division
Financial Sector Policy Branch
Department of Finance
20th Floor, East Tower
140 O'Connor Street
Dear Mr. Salembier,
We are pleased to enclose our comments on the Department's 2006 Bank Act consultation document. We put forward three policy priorities for government as it considers Canada's financial sector policy framework. We also provide comments on a number of other issues raised in the consultation document. Our priorities are for government to:
The recently released International Policy Statement provides some context for our comments. It included an international commerce strategy aimed at supporting the global engagement and competitiveness of Canada's business community. Given Canada's small domestic market, Canadian companies have had to turn to foreign markets. Continued success in these markets is not guaranteed. The conclusion of the commerce strategy is that the federal government must act now to secure Canada's economic future.
We strongly agree with this view and it is from this perspective that we are concerned that the bank merger guidelines have not yet been finalized. This must be done to give banks greater flexibility in domestic and international markets.
We also encourage the federal government to broaden the scope of its review, since we believe it would be a mistake to delay the consideration of significant issues until 2011. We believe it's essential that Canada's regulatory framework continue to provide an important advantage for Canadian companies competing in international markets. Our recommendations would increase the flexibility of Canadian banks so that they may better serve Canadian consumers and businesses and continue to succeed in global markets.
A good example of where flexibility can be increased and competitiveness improved is the bank holding company framework. Introduced in the 2001 Bank Act, it has yet to be finalized – and, as it currently stands, it will not meet its objectives. Government is making progress in terms of the capital, tax and regulatory policies to be applied, but further effort is needed to resolve the remaining issues, particularly the framework's failure to provide a material benefit in terms of capital and regulatory relief.
Similarly, while we fully recognize that overall Canadian control of the financial sector is a critical element of Canada's financial sector policy and should be maintained, we believe further debate is needed around bank ownership policy, particularly with respect to additional flexibility that may be possible.
We are supportive of the proposals put forward in the consultation document to improve the regulatory framework (eliminating regulatory overlap and improving approval processes). However, we have concerns with the proposal to eliminate the 75 per cent loan-to-value limit. We believe removal of the limit will reduce the size and quality of the pool of insured mortgages. This will substantially increase the cost of insurance for those consumers on the margin, and it will reduce the availability of insurance in certain geographic regions where low re-sale values and economic risks make insurance far more costly. Both of these consequences work against the goal of broadening the base of homeownership in Canada.
We look forward to the opportunity to discuss these issues in more detail at your convenience, and pass along our full support for your efforts to update and improve the industry's legislative framework.
A response to the Department of Finance consultation document for the 2006 review of financial institutions legislation
"Providing Canadian banks with more flexibility to seize opportunities to grow and to improve their competitive strengths in their home market is essential for them to succeed internationally."
June 1, 2005
Scotiabank is pleased to have the opportunity to provide input into government's consideration of reforms to the Bank Act as part of its five-year review cycle.
The decision to require a five-year review of the Act rather than the previous 10 year cycle is one of several policy decisions that have provided Canadian financial institutions, including banks, with an enlightened policy framework. Canadian consumers and financial institutions have benefited from a policy framework that has led to a safe, efficient and competitive national banking system that can compete effectively on a global basis.
The five-year review helps keep the framework current with market developments and international competitive challenges. In particular, this review provides an opportunity to assess reforms introduced in 2001. It was in that round that government began to implement recommendations made by the Task Force on the Future of the Canadian Financial Services Sector in 1998. Several of the recommendations continue to be relevant today and this review allows us to assess progress and next steps.
We strongly encourage the federal government to continue to implement the vision of the Task Force. We take to heart the warning of the Task Force that, given the emerging challenges facing Canada's financial sector, complacency and the failure to adjust will most certainly lead to problems. In particular, the Task Force found that the policy, legislative and regulatory framework will have to "contain considerable flexibility – certainly more than currently exists." That statement was made in light of rapid changes through the 1990s. Clearly, the pace of change has accelerated since then and so the need for regulatory flexibility is even greater today.
II. Scotiabank's priorities
In this context, we strongly believe that government needs to broaden the scope of its review. Several issues are not included in the consultation document, and we believe it would be a mistake to miss this round of reform and delay the consideration of significant issues until 2011. It is too long a wait to address what is an eroding comparative advantage for financial institutions – a progressive and forward-looking legislative regime. Despite political challenges and tight timeframes, we must not allow ourselves to be satisfied with "good enough." The sector is too important to Canadians for this round of reform to be largely a technical review, when there are real questions of international competitiveness to be addressed.
The federal government's recent International Policy Statement stressed this perspective. The international commerce strategy that was part of the statement addresses some of the drivers of competitiveness for Canadian business, including smart regulation. We fully support making the regulatory system a key competitive advantage for Canada. Future economic prosperity depends on Canadian businesses having the tools and the environment here in Canada to succeed against strong competitors in key markets around the world. At the same time, Canadian banks need to be in a position to grow and support Canadian companies as they expand.
We encourage the federal government to build on the 2001 financial sector legislation and the framework established by the Task Force to support a stronger sector that can better serve Canadian consumers and businesses. Canadian bank profitability has contributed to the strength of the sector, putting Canadian banks among the world leaders over recent years in terms of total return to shareholders; however, this needs to be combined with sustained growth – growth in terms of new geographic markets, new business powers and new capabilities. An essentially static legislative environment puts Canadian banks at a disadvantage relative to larger competitors in an evolving international marketplace.
Providing Canadian banks with more flexibility to seize opportunities to grow and to improve their competitive strengths in their home market is essential for them to succeed internationally. A good example of how regulation could provide increased flexibility is the bank holding company framework, first introduced in the 2001 Bank Act revisions, but yet to be completed as we consider the 2006 Bank Act. The promise of this reform was additional structural flexibility, capital and regulatory relief – all important improvements to the overall competitiveness of the industry.
1. Bank holding company (BHC) regime
In 1998, the Task Force proposed this structure, in part to facilitate a move to functional regulation, where a lighter regulatory regime would apply to non-deposit-taking entities within the holding company. We believe this is fundamental to a successful BHC regime. While government is making progress on several fronts in terms of the capital, tax and regulatory policies to be applied to a BHC, these policies do not yet create a material benefit in terms of additional competitiveness. There is no incentive to absorb the significant cost of conversion. As a result, the BHC regime does not currently achieve its objectives.
We strongly urge the federal government to work with OSFI to ensure the BHC regime is tax neutral and that it provides clear capital and regulatory relief. This regime needs to be finalized as soon as possible.
Capital relief must provide, at a minimum, a level playing field with international standards and domestic competitors (e.g., non-operating life insurance companies). It must also recognize that the holding company structure is significantly different than the parent-subsidiary structure. This is true for capital adequacy, and it is also true for how a holding company is supervised. There needs to be a material benefit in terms of regulatory relief. The failure to exempt BHCs from related-party rules is a good example of an unnecessary regulatory burden that should be eliminated for BHCs. Related-party transactions would still be appropriately supervised by OSFI.
2. Ownership policy
Additional flexibility through changes to the ownership regime were also recommended by the Task Force and introduced in the 2001 Bank Act. We recommend that government consider further reforms to the ownership regime. We fully recognize that overall Canadian control of the financial sector is a critical element of Canada's financial sector policy and one we fully support. With this in mind, we believe further debate is needed on bank ownership policy, particularly on the degree of additional flexibility that may be achieved.
For instance, the Task Force put forward the scenario where a "Canadian financial institution might be unable, for reasons of capital or other business constraints, to pursue an expansion of its business in Canada even though it might add a vitally important competitive force to Canada's financial services market. Such an institution might be an attractive candidate for acquisition or significant investment by a widely-held financial institution based outside Canada that is interested in expanding operations in Canada."
The Task Force recommended that the government have the flexibility (only in exceptional cases) to approve the acquisition of a large Canadian institution by a widely-held, regulated foreign financial institution, free from the impact of the widely-held rules. Any such transaction should be subject to approval by the Governor-in-Council on the basis that the acquisition would significantly enhance competition in the domestic market or increase safety and soundness, and there should be a provision for enforceable undertakings to ensure that the transaction provides such benefits to Canada. The Task Force made clear that the financial services sector should remain Canadian controlled, although it does not follow that every major institution must be Canadian controlled.
We believe there is merit in government considering this view. Such a change in policy would provide additional flexibility to the federal government to consider foreign ownership possibilities, if it deemed it in the national interest. It would be a forward-looking measure, fully consistent with the direction of international trade and investment liberalization. It would also give the Canadian banking sector additional flexibility to adjust to future competitive challenges.
Similarly, we believe the bank merger guidelines should be finalized and published.
The policy decision to permit large bank mergers was made in 1999 and the necessary changes to the Bank Act were made in 2001, including the publication of the merger guidelines. The guidelines have since been studied by two Parliamentary committees with public hearings. The guidelines must be finalized to give banks greater flexibility in domestic and international markets.
75 per cent loan-to-value mortgage insurance requirement
We also raise, as a priority for the Bank, concerns over the proposal in Annex 6 to eliminate the 75 per cent loan-to-value limit that triggers the need for mortgage insurance. While we are supportive of the removal of any restriction that cuts against the public interest, we believe the mortgage insurance market has evolved with this as one of its key features and it remains a key feature today. With a primary goal of expanding access to affordable housing across the country, the 75 per cent loan-to-value limit has ensured a large enough population of mortgagees in this category of borrowers to diversify risk and thereby lower insurance costs and the overall affordability of homes.
Reducing the size and quality of the pool of insured mortgages by removing the limit will work counter to this objective. As the Canadian Bankers Association states in its submission, this proposal requires considerably more study before any decision is taken. In fact, evidence points to few consumers benefiting from the removal of the limit, while many, particularly those most in need of affordable financing, will suffer. The net effect will be to make it more expensive for those on the margin (e.g., those consumers with lower incomes or weaker credit ratings), working against the goal of broadening the base of homeownership. This will also affect certain geographic regions of the country, making mortgage insurance considerably more expensive for areas where there is less housing re-sale activity and/or economic stability, again working against the goal of broadening the base of homeownership.
The limit is a fundamental aspect of the Canadian mortgage market, and should not be eliminated without conclusive evidence that the net consumer benefit will be positive.
III. Other issues
In addition to these three priorities, we outline below issues we believe warrant discussion and inclusion in the current legislative review. There are several areas where it is possible, and necessary, to build on the strengths of the 2001 financial services legislation to support this key sector of the economy. We have divided our comments under the following four headings which we believe provide a useful framework:
Our comments are limited to Scotiabank's key interests and they should be considered in conjunction with the submission of the Canadian Bankers Association, which we support.
3. Enhance competition and competitiveness
The Task Force provided recommendations to improve competition within the Canadian marketplace and, at the same time, strengthen the international competitiveness of Canadian financial institutions. It recommended increased business powers and greater structural and organizational flexibility. We believe that further progress is required in these areas from the start made in the 2001 round.
The Task Force also believed strongly that providing wider choice to consumers and encouraging new competition should have a higher policy priority than attempting to preserve the current prohibition on branch distribution of insurance. It recommended a series of consumer protection measures and a transitional period to allow the insurance sector to adjust to increased competition from banks. The consumer protection measures were put in place following the 2001 Bank Act changes and the transition period has worked effectively. We believe it is now time to provide consumers with the benefit of increased choice.
While we oppose, in principle, consumers being denied the freedom to choose whether they wish to obtain insurance in bank branches, we propose that banks be permitted a measured expansion of their current activities to demonstrate the consumer benefits that would result. What we are proposing does not go as far as the recommendations of the Consumer Association of Canada in its recent submission to the Senate Banking Committee – to permit banks to sell insurance in their branches under appropriate protections – simply because we recognize that the transition to full competition in Canada's insurance markets may be best addressed on an incremental basis.
Specifically, we recommend that the Bank Act be amended to provide consumers with the additional convenience and choice of obtaining information on life insurance products within bank branches. In addition, with explicit customer consent, we believe banks should be permitted to share customer information to allow tailored insurance information to be sent to existing bank customers. On this same basis, we believe banks should be permitted to refer customers to licensed insurance professionals operating outside the branch in separate premises.
Providing customers with additional sources of information about insurance, subject to their agreement, under a monitored regime of transparency, disclosure and redress, is fully in the consumer interest. Canada is unique among industrialized economies in keeping this restriction and, in fact, Canadian insurance companies have recognized the consumer value of branch distribution and are successfully selling insurance through bank branches in other countries.
It will make a distinct improvement in the Canadian marketplace without disrupting existing sales channels. The market for insurance will be broadened for all sales channels through increased choice and convenience for consumers, especially for the less affluent, who will have new opportunities to consider their insurance options. Consumers' interests are fully protected by their freedom to choose and their control over personal information. As well, advice would continue to be provided only through licensed professionals outside the branch.
We also recommend that the list of authorized insurance products be expanded to include life-contingent annuities and creditor insurance up to the value of the authorized limit. Both of these products are fully consistent with the business of banking. This change would not disrupt the insurance market, but would provide meaningful value for our customers and the ability of banks to better serve existing customer relationships.
In fact, in the case of annuities (or any savings vehicle that is insured or guaranteed), the additional access provided to consumers regarding their savings and retirement options is of significant and growing value. Canada has an aging population with an increased life expectancy, combined with a declining rate of household savings. Plus, Canadians are taking on increasing risk for their retirement. Not surprisingly, a majority of Canadians are concerned that they may not have sufficient funds to cover their retirement needs.
Scotiabank's international experience clearly demonstrates how we can help serve the retirement savings needs of our customers by providing access to annuities, savings and insurance vehicles to cover risks. For example, in Jamaica, where we have been providing a life insurance and investment product since 1998, we have been able to serve the retirement and educational savings needs of middle and lower income bank customers. This combination offers financial protection should untimely events prevent them from fulfilling their savings goal. The purpose of the product is to fill a savings and investment need, not a life insurance need. It does this successfully for customers who likely would not otherwise plan and save for education and retirement.
We would be pleased to provide more details on how our international experience illustrates the gap in Canada that is being served in other markets around the world.
b. Commercial investment powers
We are pleased to see consideration is being given to a limited expansion of commercial investment powers. We fully support the federal government's efforts to reduce the complexity of the Bank Act's treatment of financial-commercial links. We believe the additional flexibility that would result is fully manageable, from a prudential perspective, under appropriate restrictions, such as a basket clause based on a portion of regulatory capital.
4. Improving the regulatory framework
Two changes to the regulatory framework the Task Force recommended were eliminating regulatory overlap (e.g., between OSFI and CDIC) and improving approval processes. We strongly support the inclusion of both initiatives in the 2006 Bank Act.
3. Corporate conduct
While we believe our role and contribution to local communities is becoming better understood – in part through the publication of our public accountability statement – there continues to be significant public concern about corporate governance. Efforts to provide flexibility for Canadian companies to meet emerging international standards of corporate governance and compliance are essential for Canadian competitiveness. For instance, we're supportive of the industry recommendation in the CBA's submission to allow banks the flexibility to report in US GAAP or IFRS. We strongly encourage the Department of Finance to continue to focus on ways to provide flexibility across the range of international regulatory initiatives, where diverging compliance requirements can have a direct impact on competitiveness (e.g., Basel, Sarbanes-Oxley, international accounting standards, privacy).
4. Empower consumers
The Task Force argued that consumers can play a more effective role in creating competition in Canada if they can comparison shop, make informed choices and rely on an effective redress system. The Task Force also recommended several consumer protection measures to strengthen basic consumer rights (e.g., privacy protection and protection from coercion). We believe an effective consumer protection regime has been put in place with changes introduced in 2001, including an effective redress system monitored by the Financial Consumer Agency of Canada (FCAC). We also believe that the financial market in Canada is extremely competitive, perhaps best demonstrated by the increasing degree of comparison shopping taking place. Still, there is room for improvement in terms of transparency and disclosure to build on this strength.
Scotiabank is taking a leadership role in the development of plain language documentation and strongly believes that this is fundamental to improving the consumer interest in Canada. We strongly encourage the federal government and the FCAC to focus their attention on supporting the efforts of individual institutions to develop plain language documentation. We do not believe this is an area that should be further regulated. In fact, competition among institutions in this area will drive consumer benefits. This is an area where the industry and government can continue to work together.
In the area of disclosure, we believe further efforts by the industry to provide more detailed cheque-hold policies will also serve the consumer interest. While implementation of the Truncation and Electronic Cheque Presentment initiative holds significant promise of reducing the maximum cheque-hold periods employed by banks, there may be scope, in the meantime, for banks to improve their cheque-hold policies and to communicate these changes to their customers. We would be interested in exploring this possibility with government.
We also recognize that improved disclosure and awareness around the Bank's redress system is possible and in the consumer interest. This was a recommendation of the Task Force: "Regulated financial institutions should be required to include information about the Ombudsman system, in an agreed format, in regular mailings to customers." We will be examining ways to raise awareness of the redress system and our customers' rights.
We recognize that policy considerations cannot be divorced from the political environment and practical realities. By the same token, we believe it would be a serious mistake for government to preclude discussion and consideration of significant policy issues facing the sector on the assumption that reasonable and sound policy would fail to succeed. We believe the issues are too important to ignore.