- Consulting with Canadians -

BMO Financial Group Submission in Response to Finance Canada's Large Bank Mergers in Canada:

Response to consultation paper re:

Additional Significant Financial Services Issues and the Bank Merger Review Process

December 19, 2003

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In its June 23, 2003, response to the reports of the House of Commons Standing Committee on Finance and the Standing Senate Committee on Banking, Trade and Commerce on the public interest implications of large bank mergers, the Department of Finance raised questions additional to those explicitly dealt with in the Committee hearings and on which BMO Financial Group has already provided input.

As we stated in our brief to the House of Commons Standing Committee on Finance, we acknowledge that there is a valid public interest component in how the financial services sector is organized and how it functions for individuals, businesses of all sizes and the overall economy. The public interest review process, the main features of which the Ministers outlined in their response to the House and Senate Committees' reports, provides a balanced, transparent framework for assessing how proposed mergers will serve the public interest and provide benefits to Canadians.

The supplementary issues raised by the Ministers fall into two broad categories: (1) industry structure: the number of large financial institutions and the encouragement of added competition and cross-pillar mergers; and (2) merger process: 60-day window and role of divestitures.

We believe there are several general principles upon which public policy on banking consolidation (and, indeed, financial services policy, in general) ought to be based.

First, the extensive and protracted focus on process issues, begun in 1997, should be concluded. The federal government has long since determined that bank mergers should be allowed subject to satisfaction of defined conditions. We submit it is time to finalize the bank merger process. As a matter of fairness, once the transition to the new government is completed, the Minister of Finance should confirm the validity and relevance of the current consultation, its timetable for completion (June 30, 2004), and its effective date for receipt of bank merger applications (September 30, 2004).

Second, industry-specific policy should be oriented towards removing impediments to competition rather than to attempting to prescribe competitive outcomes. Market forces, in combination with technological change and process innovations, have proven to be very effective mechanisms for ensuring that Canadians get improved quality from banks and other financial services institutions at competitive prices. The evidence from such diverse sources as the secular decline in margins and spreads, the inter-country comparisons of fees and commissions and the impact on product pricing of new entrants (with very small market share) such as ING are testimony to the contestability of financial services product markets in Canada.

Third, in assessing the impact of prospective financial services consolidation on Canadians as purchasers of financial services (whether they be households, small firms or large corporations), the Minister of Finance should rely heavily on the expertise inherent in the federal Competition Bureau. It was created to address public interest concerns through the application of its competition policy. The Competition Bureau is best equipped to adjudicate the consequences of mergers, and to propose remedies for unacceptable influences on competition.

Applying these general principles to the questions raised by Ministers leads to the following conclusions:

The government should avoid determining in advance what the structure of the financial services sector ought to be.

It is our view that Government should remove the ban on mergers between banks and insurance companies and the limitations on the sale of insurance through bank branches to assure that the market is open to the fullest possible competitive pressures. By allowing mergers in a more broadly defined financial services sector, concerns that have been expressed about the number of large financial institutions after consolidation could be obviated. If cross-pillar mergers and mergers among large insurance companies are permitted, we believe that it is reasonable that they be subject to the same review process required for large bank mergers.

Further, the number of large financial institutions in Canada should not be specified. To do so would unduly influence the type and number of competing business proposals. The appropriate mechanism for ensuring that the sector remains competitive after consolidation and, therefore, for effectively determining the appropriate number of financial institutions, should be made by the Competition Bureau.

Nor do we support the proposal to create a 60-day window following receipt of a merger application to allow others in the sector to determine whether to bring forward a merger application. This would be an arbitrary and unnecessary interference with both market and regulatory processes. No other sector is subject to such a notion, nor should the banking sector be.

As we stated in our briefs to the Parliamentary Committees, when the Competition Bureau requires divestiture, the Government may ask that merging banks first try to sell these branches to financial institutions with smaller Canadian branch networks, such as credit unions, regional banks or foreign banks. This would allow them to extend their market reach and strengthen their market position, in effect creating new levels of competition. Having said that, it could make the divestiture process unworkable to require that credit unions, regional banks, or foreign banks be the only competitors permitted to be purchasers of the divested branches. In any event, so long as there is a buyer, the local market will continue to have the same number of competitors as before the merger.

We do not perceive the absence of full functionality at automated banking machines to be an impediment to competition. There are absolutely no restrictions on financial institutions negotiating the structures, responsibilities and prices of an agreement on ABM functionality. Nor do we view it as sound public policy for the Government to attempt to mandate that full functionality become a marketplace reality. First, decisions about deployment of ABMs and about the financial service functions they provide are a key element of each institution's marketing strategy. Mandating that a competitive advantage be ceded to competitors – especially at a government-prescribed price – will stifle innovation and development of this channel. Second, there are significant operational complications with handling deposits, especially cash deposits, that are made by customers of another financial institution. Finally, there are issues about which institution has liability for the transaction – the one where the deposit is made or the depositor's institution.

With respect to whether the government should pursue additional efforts to encourage increased competition, we would agree that current restrictions on foreign bank retail deposit-taking be removed subject to two provisos: that the foreign bank is adequately regulated in its home country and that such deposits be insured by CDIC under its risk-adjusted premium structure.

In conclusion, we submit that the issues raised by the government should not delay the announced merger process timetable. We share the government's belief, stated on June 13, 2000, that "mergers can be a viable business strategy" and that financial institutions should "have the flexibility they need to adapt to the changing marketplace, to compete and thrive, both at home and abroad, and to retain their role as critical sources of economic activity and job creation".