Chapter 1.

THE PROPOSED BANK MERGERS

1.0 INTRODUCTION

ON JANUARY 23, 1998, the directors of the Bank of Montreal and the Royal Bank of Canada announced the proposed merger of their two banks into a single new entity. On April 17, 1998, the directors of CIBC and TD Bank followed suit with the announcement of a proposed similar merger of their respective institutions.

These mergers, if approved, would fundamentally and irrevocably change the landscape of the Canadian financial services sector. They would further dramatically consolidate what is already the most heavily concentrated banking system among all the G-7 group of leading industrialised nations. The two mega-banks resulting from the merger would together account for 70% of core banking markets.

Assessing the merit and desirability of these mergers is a matter that touches all Canadians. The National Caucus Task Force starts from the premise that the major chartered banks play a unique economic and social role in our national life. As Michael Mackenzie, the former Superintendent of Financial Institutions, has stated: "These banks are special and should be looked at essentially as public utilities underpinning the economy."¹

In a similar vein, Raymond Garneau, president of Industrielle-Alliance, emphasised to the National Caucus Task Force: "Banking is a privilege, not a right. Banks have a social responsibility." This same point was made earlier in the Government's own February, 1995 White Paper on financial institutions, which stated: "The ownership of a financial institution is a privilege, not a right."

The additionally unique role that the banks play in smaller communities is aptly summarised as follows by Adam H. Zimmerman: "Our banks are more than counting houses - they are places of meeting, places where the uncertainties of financial life can be cleared for those that wish, they provide competition for the little guy borrowing his money, and they are true pillars of the community."²

Accordingly, the focus of the National Caucus Task Force in examining the proposed bank mergers has been on exploring whether they are in the public interest.

The members of the National Caucus Task Force came to this issue with a variety of perspectives, but were united from the start by a shared view that mergers are neither good nor bad in themselves. The key test in any given instance is whether the consequences of a particular merger are ultimately likely, on balance, to benefit or to harm ordinary Canadians, small and medium-sized businesses, and the broad national interest. We were determined to arrive, through our hearings and research, at the facts in order to answer this question.

This is consistent with the approach recommended by the Task Force on the Future of the Canadian Financial Services Sector, which states in its final report: "The potential impact of a merger transaction on the public interest grows as the size of the merging institutions increases...Every significant merger proposal gives rise to its own unique set of public interest considerations that must be examined carefully by the Minister of Finance."³

Indeed, this emphasis on the public interest has been endorsed by Royal Bank Chairman and CEO John E. Cleghorn, who acknowledged to the Caucus Task Force: "Ultimately, if these mergers are not good for Canada, they should not be done."

In seeking to provide advice and assistance to the Minister of Finance in assessing the public interest considerations, the National Caucus Task Force has adopted a cost-benefit approach. We have examined the purported benefits of the mergers that have been cited by the merger-seeking banks and other proponents, as well as the purported adverse consequences that have been identified by critics of the proposals.

The premises underlying this approach were the following:

• If the likely benefits arising from the mergers appear great while the potential adverse consequences appear likely to be small, the mergers are in the public interest and should be allowed to proceed.

• If the benefits appear likely to be modest or non-existent but there is also no likelihood of significant adverse consequences, the mergers do not have important public interest implications and can be allowed to proceed as a business decision.

• If the benefits appear likely to be modest or non-existent, but the adverse consequences are likely to be significant, the mergers are contrary to the public interest and should not be approved.

• If the benefits are likely to be great but the likely adverse consequences are also great, that presents the toughest public policy dilemma. Then it would be necessary to assess who stands to benefit and who stands to be harmed, and which course is likely to be the more consistent with the national interest and Canadian values.

Accordingly, the following sections of this report will state findings as to the likelihood of purported benefits and the risk of potential adverse consequences, and then provide recommendations as to the appropriate course of action.


2.0 PURPORTED BENEFITS OF THE MERGERS

Relative to the enormity and importance of the changes they are proposing, the four merger-seeking banks have never presented as clearly defined and persuasively documented a case as Canadians were reasonably entitled to expect. But they do argue, with noticeably differing degrees of conviction, that there are a variety of ways in which the proposed mergers would benefit not only the institutions themselves, but also the Canadian public and the broad national interest.

There is a major qualitative difference in the respective cases put forward by the two sets of merger-seeking banks.

Only Royal Bank and Bank of Montreal argue unequivocally that the mergers are inherently desirable on the strength of the purported benefits the mergers would bring. CIBC and TD Bank, on the other hand, see their merger as defensively necessary in response to the Royal-BMO merger. Both CIBC Chairman Al Flood and TD Bank Chairman Charles Baillie candidly admitted to the National Caucus Task Force, in response to questions, that their institutions would not have sought a merger except for the prospect of a united Royal Bank-BMO.

As Mr. Baillie explained it, faced with the prospect of a domestic competitor three and a half times its size, TD decided it had no choice but to find a partnership with another Canadian bank. Merging is not necessarily the best thing to do, Mr. Baillie said, but the TD simply had no choice but to take such action in order to survive.

Having adopted this course, both CIBC and TD offer arguments about the benefits of merger that are similar to those advanced by the Royal Bank and Bank of Montreal. They also say that they probably would have contemplated a merger some time in the future. But, not surprisingly, the Caucus Task Force was struck by a certain perfunctory quality and lack of conviction in their presentations.

The simple fact is that of Canada's five biggest chartered banks, only two believe that mergers at this time are, inherently and on their own merits, a good thing. Two are reluctantly making a virtue of what they regard as necessity. And the fifth, Bank of Nova Scotia, is actively opposed. The sixth largest, National Bank, is also opposed.

That being said, the broad public interest benefits cited by the merger-seeking banks and their supporters are the following:

• They would assist the Canadian banking industry in being on the leading edge of technological innovation.
• They would generate economies of scale and scope that will enable the new mega-banks to provide Canadians with better services at lower cost.
• They would enable the banks to withstand growing foreign competition in the Canadian domestic market.
• They would enable the new mega-banks to be more competitive internationally.

The National Caucus Task Force has examined each of the benefits advanced in detail.

2.1 Enhanced Technological Innovation

2.1.1 Spending on technology

The announcement of the proposed BMO-Royal Bank merger referred to "investing more than $7 billion over the next five years in developing state-of-the-art technology for the future."

In a subsequent speech to shareholders at the Bank of Montreal's annual meeting on February 24, 1998, Chairman Matthew Barrett expanded on this commitment, saying: "When we announced the proposed merger, we undertook to spend $1.4 billion on research and development each year. That will mean not only better service for our customers, but contracts for our suppliers and well-paid jobs for Canadians who work for us and our hundreds of suppliers."

Impressive though these numbers sound, in reality they represent absolutely no increase whatsoever in intended spending on research and development after the proposed merger.

In the same speech to shareholders, Mr. Barrett stated that in 1996 Royal Bank spent $750 million on R & D, while BMO spent $640 million; this totals $1.39 billion.

The figures for 1997, included in a fact sheet accompanying the merger announcement, showed investment in technology of $750 million by Royal Bank, and $674 million by BMO, for a total of $1.42 billion.

So the two banks are currently spending $1.4 billion a year on technology, and they intend to spend $1.4 billion a year - which totals $7 billion over five years - after the proposed merger. With no increase from current spending, it seems less likely that there will be significant benefits, or that there will be "better service for customers" or more contracts and jobs for suppliers. What is most striking, in fact, is that despite the importance they purport to attach to technological innovation, and the overall savings they claim would result from post-merger economies and efficiencies, the two banks plan no increase in spending on technology if the merger is allowed to proceed. Perhaps the implication behind the claim of technological benefits arising from merger is that by eliminating duplication of spending on R & D, the merged banks would be able to make the same dollars go further. But even this may be questionable, for several reasons.

First, mergers would require integrating the systems and technologies of the merging banks. This itself would entail considerable expenditures that would eat up at least some of the savings from reduced duplication of R & D. This presumably also accounts for much of the $1 billion in restructuring costs that each of the two proposed mergers is expected by the merger-seeking banks to entail. The resulting tax write-offs totalling $1 billion would be a cost to the Canadian government which would have to be made up by other businesses and Canadians at large.

Second, much of the money banks spend on technology is devoted to maintenance and enhancement of their existing or "legacy" systems, rather than to new and improved technology. Mr. Barrett appears to use "technology" and "R & D" interchangeably, but typically banks devote only one-third to one-quarter of their total technology spending to new development which does not necessarily qualify as R& D. For instance, only 25% of CIBC's technology spending and 35% of TD's is for new development.⁴

Since maintenance expenditures would not likely be significantly reduced by merger, only a small portion of technology spending would be subject evento potential reductions of duplication which might free up funds for new development.

Third, and perhaps most important, it is competition, not consolidation, that is most likely to spur technological innovation in the banking sector. Such technology-based innovations as daily interest accounts and weekly mortgage payments, for instance, have come from smaller players looking for a competitive advantage.

The larger you are, the less you have to innovate. In fact, the consolidation of the top tier of our system from five banks into two mega-banks and one much smaller "big bank" could well reduce domestic competitive pressures and lead to a net reduction in spending on technological innovation.

2.1.2 Technological Positioning

There is no evidence that Canadian banks are lagging in technology to such an extent that a remedy as drastic as merger is necessary or justifiable, even if one accepted the highly dubious proposition that it would be effective.

The number of ATMs relative to population in Canada is second highest of all the OECD countries, lower only than Japan's. Our payments system is a world leader, with cheques clearing faster than in virtually any other country. And the Task Force on the Future of the Canadian Financial Services Sector reports: "An Ernst & Young report on technology and financial services prepared for the Task Force concluded that the rate of adoption of new technologies by Canadian banks is comparable to that in the other major countries examined.."⁵ In fact, the banks themselves say that they are world leaders in technological innovation.

The merger-seeking banks nevertheless suggest that they are at a disadvantage because the annual technology spending of huge American banks like Citibank, Chase Manhattan and Bank America is $3 billion, $2.8 billion and $2.2 billion respectively.

Notwithstanding that much of that American expenditure is simply for implementing and maintaining technology across a much larger market, there simply is no way that Canadian banks can come close to matching these levels of expenditure - with or without a merger. Whether Canada has two banks spending $750 million and $674 million respectively, or one mega-bank spending $1.4 billion, our banks simply cannot compete with the American behemoths on technological spending. Moreover, there is no persuasive evidence that the Canadian banking sector is lagging behind which suggests technological positioning is neither a serious problem nor a justification for merger.

2.1.3 Technology Investments Alternatives to Merger

If the banks nevertheless believe that they are not currently doing enough with regard to technological innovation, there are avenues far more promising and effective than merger that they can pursue.

For example, during periods of record profitability such as banks have recently experienced, they have the option of investing more of their profits in technology. If any business believes that its long-term stability requires a particular form of investment, prudence dictates making that investment rather than maximising short-term profit-taking.

The banks can cost-effectively develop new technologies by going even further along the path on which they have already embarked: joint ventures, merging backroom operations, and outsourcing.

For instance, Royal Bank, BMO and TD Bank have established a joint venture, Symcor, for cheque-processing, customer statements, credit card sales, drafts and remittances. Bank of Nova Scotia and CIBC have established Intria, a strategic alliance for a variety of activities including document processing, computing and ATM servicing. And Leon Courville, chief operating officer of National Bank of Canada, told the National Caucus Task Force:

"Effective technology solutions are more readily available than ever, off the shelf."

The merger-seeking banks argue that competitive considerations prevent them from going much further down the road of technological co-operation with each other without a merger. This argument is not very convincing. Technology can be jointly developed, then customised for "proprietary" client-contact details.

As a technical report by two Bank of Canada economists states: "Technical developments have led to a merger of the backroom operations of large Canadian banks, or the outsourcing of some of these activities, to take advantage of the potential economies of scale in this area. This is not a new development at all; small and medium-sized financial service providers have been doing this for some time...Financial service providers are jointly developing these products (Mondex, Visa and Proton, SVC stored-value card projects) because of network externalities as well as the significant infrastructure costs involved in the development and spread of the SVC technology."⁶

Since it has not been persuasively shown that mergers would generate significant new spending on technological innovation, since there is no evidence that the Canadian banking sector is lagging in technology, and since the banks have alternatives to mergers to advance technological development, the Caucus Task Force finds:

Finding #1: The proposed mergers are not likely to produce significant benefits for Canadians with regard to technological innovation.

2.2 Economies of Scale and Scope

The merger-seeking banks have argued that the proposed mergers would produce economies of scale and scope resulting in cost savings that would be passed on to their customers.

Economies of scale can occur when fixed costs are spread over a larger volume of activity, lowering the average cost of producing each transaction or item. Economies of scope can occur when two or more different services can be jointly produced at a lower cost, due to sharing overhead or technology, than it would cost to produce them separately.

Royal Bank Chairman John Cleghorn stated the case this way: "Scale is a very important competitive asset in the new markets of the late 1990s and the next century. The growth of retail powerhouses like Wal-Mart and Home Depot shows that size can result in more choice and lower prices for customers. In banking, the Americans, the Dutch and Swiss have demonstrated that size provides the capital and technology to compete at home and in world markets."⁷

Similarly, Bank of Montreal Chairman Matthew Barrett told the National Caucus Task Force: "The fundamental reason for this merger is simple enough. We need to achieve the productivity that will allow a Canadian bank to provide the banking service that Canadians need and want..."

And TD Vice Chairman Robert Kelly stated: "We need to merge to obtain the cost synergies of streamlining duplicate head office functions, to merge overlapping branches - mainly in urban centres - and to increase the volume of business going through them to reduce costs. Then we will be able to gain efficiencies..."⁸

The merger-seeking banks have not quantified the dollar value of the economies they expect the mergers to produce, nor have they provided details as to how these economies would occur.

For these purported economies to be regarded as a public interest benefit that is likely to arise from the proposed mergers, two conditions have to be met: It must appear likely that significant economies of scale and/or scope would in fact occur. And it must appear likely that the benefits of such economies would be passed on to the Canadian public in the form of lower costs or improved service.

2.2.1 Likelihood of Economies

The National Caucus Task Force has carefully reviewed the available literature in addition to seeking advice from witnesses who appeared before us.

We have not been able to find any indication that the kinds of mergers being pursued by the four Canadian banks are likely to produce substantial economies of scale or scope or improvements in efficiency.

In fact, the evidence appears overwhelmingly to the contrary.

One of our witnesses, Professor Laurence Booth of the Rotman School of Management at the University of Toronto, summed it up this way: "It is true that if two companies in an industry are inefficient due to technological change, then allowing them to merge may increase efficiency, since larger size may reduce overall costs. However, there is no evidence of scale economies in banking, once banks get above the small unit branch banking scale of some U.S. states. As a result, I am extremely sceptical that the merged banks will be significantly more efficient than the four constituent banks operating independently."

This view is echoed in study after study.

A 1997 survey of 23 different studies - mostly American, but including four international ones - found that for large multi-product banks, growth in size does not produce any important efficiencies of scale or scope.⁹

A 1994 U.S. Federal Reserve System report summarising the findings of 39 different studies of bank mergers in the U.S. between 1980 and 1993 concluded that most studies found no gains in overall efficiency or profitability after each bank merger.¹⁰

A top European expert, Herwig Langohr, professor of finance and banking at Insead, Fontainebleau, says: "What is known about size and profitability in banking suggests that overall institutional bigness fails to enhance profitability systematically...Among the largest 150 banks world-wide...the most profitable banks are not the largest institutions, nor the ones with the broadest product scope or widest geographic coverage...In short, profitability battles in Euroland will be won by great management and adapting organisations, not necessarily by large banks."¹¹

And, looking at mergers in general, The Globe and Mail recently reported: "Research compiled by Mercer Management Consulting, one of the world's top strategic consulting firms, shows that two out of every three mergers fails, in the sense that the new company underperforms the industry in the years after the deal...Mercer concluded that bigger is not necessarily better after evaluating about 500 American and Canadian mergers and acquisitions since 1990. In short, it found little correlation between the deals' stated driving forces - cost cutting, diversification and the like - and success."¹²

The two proposed Canadian bank mergers might well produce some short-term cost savings from rationalisation, in the form of combining head offices and closing competing branches - though even these would likely be limited by the costs and problems arising from trying to blend head offices, and by the banks' expressed commitment to minimising branch closings and job losses. But such savings from rationalisation are quite different from long-term economies of scale or scope, efficiencies or improvements in profitability.

Witness after witness at our National Caucus Task Force hearings emphasised that there is no reason to anticipate that the mergers would produce economies of scale or scope.

Andre Berard, chairman of the National Bank of Canada, said: "For our presentation to the Task Force on the Future of the Canadian Financial Services Sector, we asked our economists to examine this question. They pored over numerous studies on the subject and discovered that once a company has amassed assets of around $40 billion, there are no additional economies of scale to be achieved...The (financial institution) mergers in the U.S. have one characteristic in common: the complementary nature of the entities that are joining forces...In Canada, the proposed bank mergers concern businesses which have similar operations and which essentially cover the same territory. I fail to see how economies of scale or of scope can be achieved in such a transaction."

Professor Jean-Marie Gagnon, of Laval University, stated: "The mergers do not appear to be motivated by economy of scale considerations. Banks have a very limited base on which they can reap economies of scale, as 53% is utilised with interest expenditures and banks have no control over interest rates. This leaves 47% on which they can realise economies...BMO and Royal Bank set out in their press release a list of institutions that would be bigger than the merged entity. If you plot the capitalisation of these institutions against their return on assets, you actually find that bigger banks have lower average return. Therefore, size alone does not mean anything."

And Peter Godsoe, chairman of Scotiabank, said: "The final argument is that mergers are needed to be cost effective...Over the longer term, however, there is little evidence to support efficiency gains. A recent report by the Bank of Canada, for example, notes that 'empirical work thus far has provided no evidence that a bank has to be a mega-institution, rather than just large, to achieve most economies of scale.' Also consider that Scotiabank and TD, the two smallest of the big five, have been the most efficient banks in Canada for many, many years."

As recently as last winter, before pursuing merger himself, TD Bank Chairman Charles Baillie had a similar view: "In 1996, the latest year for which comparative figures are available, we made more money, in absolute pre-tax dollars, than six of the world's 10 largest banks. My theory is that diseconomies of scale must come into play when you surpass a certain size."¹⁴

Even Canada's top financial regulator, Superintendent of Financial Institutions John Palmer, has expressed doubts about the efficacy of mergers: "There's a sort of assumption that if the two merging entities are strong, then the resulting combination must by definition be strong, and our view is that doesn't necessarily follow. In all of the enthusiasm for global mergers, some issues have been lost sight of, such as the difficulty of putting these mergers together."¹⁵

There is a wealth of empirical evidence to support these views that there is no positive correlation between bigness and enhanced efficiency and profitability.

Particularly interesting, in view of Mr. Cleghorn's reference to American, Dutch and Swiss banks is an analysis prepared for the Task Force on the Future of the Canadian Financial Services Sector by McKinsey & Company. This international comparison of bank efficiency ratios - non-interest expense divided by total income - found that the average for Canada's five largest banks in 1996 ranked second only to the average for the United Kingdom's largest banks. Canada's banks were slightly more efficient than the average for the biggest banks in the U.S. - and dramatically more efficient than the biggest banks in the Netherlands and Switzerland. No less significantly, the most efficient among the Canadian banks was the comparatively small Scotiabank, and the least efficient was the biggest, Royal Bank.

The fact that banks don't have to be enormous to be profitable is also strikingly demonstrated by another McKinsey & Company analysis. Despite the huge disparity in their respective sizes, the average profitability (net income as a percentage of total revenue) of Canada's top five banks in 1996 was only fractionally lower than the average for the top five U.S. banks - 19.5% for Canada, compared to 20.2% for the United States. The profitability of Canada's top banks was far better than Switzerland's (15.4%), Germany's (13.2%) and Japan's (3.5%).¹⁶

At our National Caucus Task Force hearings, the chairmen of the merger-seeking banks were invited to refute the indications from international evidence that mergers of this sort are unlikely to generate economies of scale or scope. They provided no persuasive, substantive responses.

The testimony we have heard, and the information we have analysed, leads the National Caucus Task Force to emphatically reach the same conclusion on this point as the Task Force on the Future of the Canadian Financial Services Sector: "The evidence we have reviewed does not sustain a case that, for most purposes, size is a strategically important variable or that all, or even most, mergers tend to bring about gains in efficiency."¹⁷

2.2.1 Likelihood of Efficiency Benefits Reaching Canadians

Since it appears clear that there is no persuasive reason to believe that the proposed mergers would produce significant efficiencies of scale or scope, it seems rather moot to ask whether the benefits of any such efficiencies would likely be passed on to the Canadian public.

Nevertheless, the evidence in this regard, too, is not encouraging.

Examining the American experience with the aftermath of bank mergers, a recent article in US Banker reported: "On balance, it's hard to see how consolidation has clearly benefited most consumers thus far. Large banks offer more distribution options, but their economies of scale have not resulted in lower fees, and post-merger service disruptions are still more the rule than the exception...In fact, there is strong anecdotal evidence that many retail and small business customers grow disenchanted after their old bank has been acquired, thanks to fee increases, service disruptions and shifts in strategy that may lead the new bank to give some customers the cold shoulder."¹⁸

The Consumers Federation of America has repeatedly complained that large U.S. banks tend to charge consumers higher prices than do small institutions.

As for the Canadian context, writer Walter Stewart made this point to the Caucus Task Force: "It is not hard to test the theory that bigger banks are more cost-efficient. Anyone can try, as I did, to negotiate terms for a credit line with six Canadian banks. Guess what? The terms offered in every case were exactly the same - 1 1/2 points over prime. The Laurentian Bank, with assets of about $10 billion, and the Royal, with assets of about 25 times that, were offering exactly the same deal. At what point, then, does a bank get to be big enough that it will give the customer a better deal than a smaller bank? If the Royal cannot do any better for me than a bank 1/25th its size, would it do so if it got to be 50 times as large?"

From a different perspective, Canadian interest rate spreads - the difference between the rate banks pay on deposits and the rate they charge on loans -are among the lowest in the world. In 1996, the spread in Canada with our relatively small banks was 1.73%, compared to such spreads in the "mega-bank" countries as 2.35% in the U.S., 2.36% in the Netherlands and 3.63% in Switzerland.¹⁹

That, too, raises serious doubts whether Canadians would gain any cost benefits from merger-enlarged banks.

Based on all these considerations, the Caucus Task Force Finds:

Finding #2: The proposed mergers are not likely to generate economies of scale or scope that would cause the merged banks to give Canadians the benefit of improved service at lower cost.

2.3 Withstanding International Competition

Perhaps the most vigorous argument the merger-seeking banks have been making is that they need to unite to withstand competition in the Canadian domestic market from huge foreign institutions.

They say they are particularly concerned about the competitive threat posed by enormous specialised or "monoline" international firms each offering a single product such as credit cards, residential mortgages or business loans. Royal Bank Chairman John Cleghorn, for instance, told the National Caucus Task Force: "Increasingly, we have to compete with huge, low-cost foreign competitors. They are using their economies of scale and expertise developed in their home market, to enter Canada or expand here. These are the so-called 'category-killers,' the monolines. They are cherry-picking profitable niches: mutual funds, credit cards, virtual banking and small business loans. They are taking business away from our Canadian banks one piece at a time."

Bank of Montreal Chairman Matt Barrett stated the issue to us in similarly alarmed terms: "We are now in danger both of 'dying from the top down' as new competitors skim off our most profitable customers, and of 'dying from the bottom up' as single-product firms with low fixed costs erode our branches' business in key products like mortgages and small business lending."

Similarly, Charles Baillie of the TD Bank told the National Caucus Task Force that the argument for merger is that "over time, if we don't do it, we will be eroded so badly by the foreign competition that we're not going to be able to innovate and compete with them."

And Al Flood of CIBC stated: "If we attempt to preserve the status quo - by not allowing Canadian banks to merge - here is what I believe will happen. Over the next five years, Canadian banks will lose their competitive edge to larger, more efficient global competitors, particularly in our home market. Canadian banks will steadily lose market share in their home markets to huge foreign, non-bank players such as GE Capital and MBNA, the giant credit card company."

If the major Canadian banks are indeed in such dire competitive peril that mergers are the only way to ensure their future viability, then it would certainly be in the public interest to allow them to proceed. But for that to be the case, it would have to be apparent both that the position of the banks is in fact significantly threatened, and that mergers are likely to offer an effective response to that threat.


2.3.1 The Threat from Foreign Competition

Although early in the merger debate BMO's Mr. Barrett compared the competitive threat to the kind of impact that giants like Walmart and Home Depot have had on the corner store, it is now generally agreed that this kind of analogy is not apt.

Royal Bank Chairman Cleghorn, for instance, told the National Caucus Task Force that he is not worried about the "Walmart of banking" coming into Canada: "No foreign bank can beat us in branch banking, so they won't come."

The barriers to entry are formidable, in terms of coping both with the established size and density of the Canadian banking system with its branches on nearly every urban corner, and with customer loyalty.

In fact, American and other foreign banking competitors are not coming in like Walmart. They are coming in very specialised fields: Wells Fargo Bank of California, for instance, offers electronic "mail-order" loans of $75,000 or less at very high interest rates, by invitation only, to small businesses. ING Bank of the Netherlands offers electronic and telephone deposit banking, with higher than usual interest on savings accounts. U.S.-based Fidelity Investments is an established player in the field of mutual funds, internationally and in Canada. Countrywide Credit Industries and GE Capital Corp. are specialised lenders. MBNA is a huge Delaware-based credit card company that specialises in scientifically-targeted marketing and offers introductory discounted interest rates.

But while such companies are depicted by the merger-seeking banks as a huge threat, there is no clear evidence that any of them - with the exception of Fidelity Investments, which has an estimated 5% share of the mutual fund market - have made significant inroads at the expense of the banks. The merger-seeking banks have not been able to provide any data demonstrating that these new competitors are succeeding in capturing significant, let alone competitively dangerous, market share. In fact, their penetration to date appears statistically insignificant.

There is considerable scepticism that the monolines pose a fundamental threat to the profitability of Canadian banks.

Andre Berard, chairman of the National Bank of Canada, told the National Caucus Task Force: "It is a fact that the Canadian banking industry must compete against niche players of colossal proportion. But these niche players

are no substitute for the banks. They are price killers targeting very specific markets which do not impact on the viability of the banks whose scope of service is definitely greater."

Scotiabank Chairman Peter Godsoe stated: "I have not seen the facts on monolines - just anecdotes. Where is the data on our loss of market share? There were six monoline credit card providers in the U.S. and now there are two. Amex has been here for years; it is a monoline credit card company."

Even with regard to mutual funds, as Manulife Financial President Dominic D'Alesssandro has pointed out, the banks hardly appear endangered: "Well, let's look at mutual funds. These two banks (Royal and BMO) held approximately $34 billion in funds at their 1997 year-end, an increase of $10 billion or 42% in just one year...I do not believe that a merger is necessary for these banks to remain globally competitive or to withstand the so-called assault on their domestic franchises by aggressive foreign competitors."²⁰

The merger-seeking banks argue that they need to take defensive action now, before they are weakened by the anticipated competition. But it would be one thing to dramatically restructure the Canadian financial services sector through such mergers in response to a clear, quantified and demonstrably grave threat. It would be quite another to regard such action as beneficial to the public interest just as a precaution, in case this latest wave of foreign competition might prove more successful than the preceding ones.

We also note that two of the four merger-seeking banks - CIBC and TD Bank - have admitted, as discussed earlier in this report, that they would not have contemplated a merger at this time if the Royal Bank and Bank of Montreal had not proposed a merger of their own. This certainly indicates that these two banks, in addition to Scotiabank, did not regard foreign competition as a problem sufficiently serious to require being addressed by mergers. The merger-seeking banks have also suggested that if they are not permitted to enlarge themselves through merger, they risk eventually being taken over by huge foreign banks.

There is nothing to substantiate this concern, since there can be no possibility of a take-over as long as the 10% ownership rule is in effect, and it would be contrary to the public interest to remove it. Without that ownership rule, however, a merged mega-bank would be an even more attractive take-over target, because its size would make it a more attractive entry-point into the Canadian market.

2.3.2 Mergers as a Response to Foreign Competition

The premise of the merger-seeking banks is that because the competitors they see entering the Canadian market are so big, the way to defend themselves is to become bigger too through mergers.

But this premise is fundamentally flawed. If sheer size and the purported economies of scale it brings are the key to competitive success in the Canadian market - which is highly questionable in itself - then the Canadian banks can never be big enough to compete with the foreign giants. The mergers would be pointless.

For instance, to illustrate the need for merger Mr. Barrett told the National Caucus Task Force that Bank of Montreal recently was beaten in competition for a major part of the federal Government's credit card business by Citibank because it was unable to match the U.S. giant's bid.

Citibank has more than 50 million credit cards. All the banks in Canada together have about 31 million. Even if all five major Canadian banks merged into a single institution, they would have barely more than half as many cards as Citibank. In any competition based on the advantages of size, consequently, it appears clear that either set of merged banks would still be far too small to be significantly better off than any of the banks individually.

Similarly, U.S.-based Countrywide Credit Industries has $228 billion in mortgages - more than all the Canadian banks combined. If that gives them competitively decisive economies of scale, then a merger of all five banks could not hope to withstand competition, let alone any combination of two of them.

But it is by no means clear, as discussed earlier in this report, that enormous size confers decisive advantages of scale on financial institutions. It seems plausible that monolines are not successful because they are big, but rather big because they are successful.

A monoline is effective not because it is a merged entity, but because it focuses highly specialised expertise on one area and offers the quality of service its target customers want. This hypothesis is borne out by the fact that huge credit card monoline MBNA Corp., for instance, was able to grow in 15 years from almost nothing to ranking second only to Citibank in number of cards. Its success, like that of many other monolines, cannot have been based on initial size, but rather on an effective strategy excellently executed.

These considerations suggest that the proposal by the merger-seeking banks to counter foreign competition by merging is not only unnecessary, but strategically mistaken. If they are seriously concerned about an immediate threat from foreign monolines and cherry-pickers, they would likely fare better by not distracting themselves over the next several years with merger implementation, and concentrating instead on innovation in marketing and excellence in service delivery.

The Caucus Task Force therefore finds:

Finding #3: The proposed mergers do not appear necessary or effective as a means of enabling the merger-seeking banks to withstand foreign competition in the Canadian domestic market.

2.4 Competing in the International Market

Three of the four merger-seeking banks say the merger is needed to enable them to compete effectively in foreign markets. Shortly after announcing the proposed merger, for instance, Royal Bank Chairman John Cleghorn said that he and Bank of Montreal want to get together so they can "kick ass" in the U.S.

TD Bank Chairman Charles Baillie, however, told the Caucus Task Force that his bank's motives differ from the institutions that say they need to be bigger in order to take on more international initiatives. The TD Bank has already done that through its discount brokerage business, he said, but wants to merge "to ensure that foreign competitors don't break apart the very fabric of the Canadian banking system layer by layer."

None of the merger-seeking banks has provided any detailed analysis of what the mergers would enable them to do in the international arena that they cannot do at present, nor how substantial they expect such gains would be.

Although they have referred to becoming "global" competitors, it is not even entirely clear from their comments whether the new mega-banks would anticipate concentrating on the U.S. market, targeting a limited number of countries, or aspiring to truly global status.

In any event, for considerations of competitiveness abroad to constitute a benefit to the Canadian public interest, it would have to be apparent both that the mergers are a necessary and a likely way to increase the international activities of the banks, and that such increased activities would significantly benefit Canadians.

2.4.1 Likelihood of Increased International Success

It is generally agreed that size can be a factor in international investment banking, since a larger capital base makes it possible to take bigger risks. But if size alone were the issue, even the merged banks would not be big enough to play in the same league as the international giants of investment banking - setting aside the broader question of whether it would be desirable for them to take part in such higher-risk activity.

But outside such specialised fields, there is no compelling evidence that bigness is essential for international success. Even in investment banking, in fact, it is often expertise, not merely size, that is the deciding factor.

Scotiabank Chairman Peter Godsoe told the National Caucus Task Force: "Look at Scotiabank's international network. We have operations in 53 countries around the world, including the high-potential markets in Latin America and Asia. We don't have to merge with another Canadian bank to achieve international success. Other Canadian bank success stories include TD's discount brokerage operations, now already third largest in the world, and CIBC Wood Gundy's successful investment banking operation in New York. And one final example is Scotiabank's success in the U.S. loan syndication market, where we're top ten year after year - competing and winning against the best banks in the world."

The merger-seeking banks have been unable to respond persuasively when asked why such international success stories by existing, unmerged Canadian banks do not disprove the purported need for merger.

Asked about Scotiabank's success in syndications in the global market, BMO Chairman Matt Barrett said only that different banks have different strategies and appetites for risk, and that Scotiabank's strategy is "way out there on the risk curve." Similarly, asked about TD Bank's also high ranking in loan syndications, Royal Bank Chairman John Cleghorn responded that the Royal has a different business strategy, concentrating on providing banking services to individuals and small and medium-sized enterprises. But he added that Royal Bank is one of the top 20 foreign exchange players in the world - another confirmation, however unintentional, that size is not an essential requirement.

Industrielle-Alliance President Raymond Garneau told the National Caucus Task Force: "Banks do not need to be big to compete internationally. Experts agree that there will always be room for niche players in the international market."

Conversely, size does not guarantee success in international activities. Marcel Côte, co-founder of Montreal consulting firm SECOR and a former director of strategic planning in the Prime Minister's Office under Prime Minister Brian Mulroney, told the National Caucus Task Force: "An examination of the top 15 banks in the world reveals that there are very few global competitors. Citibank is the only one. Deutsche Bank blew its global strategy.

The rest are simply banks that are big in their own countries, like NationsBank and all the Japanese banks...If the mergers proceed, the Canadian banks will still be largely irrelevant in the U.S. and will have no significant presence in other countries."

Similar views are expressed by no less an authority than Bank of Canada Governor Gordon Thiessen, who said recently that he has never seen proof to convince him that banks need to be big to compete internationally.²¹

The case simply has not been made, therefore, that mergers are the only or the best way for the banks to increase their international competitiveness, nor even that they would be likely to have that effect.

2.4.2 Purported Public Interest Benefit of Increased International Activity

Even if the proposed mergers did enable the merged banks to be more successful in international activities - which has not been demonstrated - it is not at all clear why this should be considered a priority from the point of view of public interest.

It is generally true, of course, that Canada is a trading nation and it is desirable for Canadian companies to continue to be internationally active and successful. But as discussed earlier in this report, Canada's major banks are not merely business enterprises like any other. They play a unique economic and social role in our national life. That is why the focus of the National Caucus Task Force, as compared for instance to that of the MacKay task force, has been overwhelmingly on the broad public interest.

For Canadians, the priority is for the banks to provide excellent, affordable services to individuals and businesses, particularly small and medium-sized enterprises, here at home. That a greatly increased emphasis on international activity would serve this priority, rather than distract from it, is not clear. It might or might not be good strategy from a narrow business point of view, but serving the public interest sufficiently to serve as a justification for the mergers is a very different matter.

The merger-seeking banks imply that the revenues from a greatly increased international presence would enable them to serve Canadian customers better and more cheaply. But Bank of Montreal currently earns 60% of its revenues outside Canada, while the Royal Bank earns only 30% abroad - yet BMO's service charges and loan rates are no lower than the Royal's, or in fact than any of the other financial institutions including the relatively small National Bank or the credit unions.

There appears to be little evidence that any increased international activity generated by the proposed mergers would, in fact, benefit Canadians at large and the public interest.

Based on all these considerations, the National Caucus Task Force finds:

Finding #4: The proposed mergers do not appear necessary, or likely, to benefit the public interest by significantly increasing the competitiveness of Canadian banks in the international market.

2.5 Conclusions Regarding Purported Benefits

In all their respective presentations before the National Caucus Task Force, and in all the other statements they have made and materials they have released since announcing the proposed mergers, the merger-seeking banks have not provided any persuasive evidence or analysis to substantiate the purported benefits they say would result.

If there were other, independent indications that the anticipation of such benefits is in fact realistic - or if, at least, there were no strong indications to the contrary - it might be possible to give the merger seeking banks the benefit of the doubt in this regard.

But the overwhelming weight of empirical evidence and expert opinion we have encountered is that the proposed mergers are neither likely to produce the benefits that have been cited, nor necessary to address the circumstances which their proponents have described.

The National Caucus Task Force therefore has no choice but to find:

Finding #5: There is no persuasive evidence that the proposed mergers would overall produce any significant benefit for the Canadian public interest.

3.0 PURPORTED ADVERSE CONSEQUENCES OF THE MERGERS

From both the submissions made to the Caucus Task Force and the feedback individual Members of Parliament have received from constituents, it is clear that a great many Canadians are deeply concerned that the proposed mergers would be harmful to the public interest in a variety of ways.

Such concerns have been expressed by individuals and organisations, by representatives of businesses and of consumers.

Specifically, the National Caucus Task Force has been told that the proposed mergers could have the following possible adverse consequences:

• Excessive concentration in the Canadian banking sector, with resulting diminished competition.
• Higher service charges and borrowing costs, and reduced choice, for individual customers.
• Branch closings.
• Reduced access to credit and services for businesses, particularly small and medium-sized enterprises.
• Reduced services to rural communities.
• Job losses.
• Increased risk of systemic failure.
• Challenge to the democratic authority of government.

The National Caucus Task Force has carefully examined each of these concerns.

3.1 Excessive Concentration

The proposed mergers would give the two new mega-banks a degree of dominance over Canada's banking sector that is unmatched anywhere in the industrialised world. Together, they would control over 70% of Canada's domestic banking assets.

This would be a degree of concentration substantially higher than even in the two countries frequently cited by the merger-seeking banks as examples of successful consolidation, Switzerland and the Netherlands. In Switzerland, the two largest banks control 57% of total domestic banking assets, and in the Netherlands 40%. In the U.S., the comparable figure is only 26%.

The merger-seeking banks argue that the proposed degree of concentration is far less dramatic if one looks not only at Schedule I banks, but at the broader financial sector including Schedule II banks, trust companies, credit unions, caisses populaires and monolines.

But this appears to be a red herring. The fact is that most Canadians do their banking at Schedule I banks. The banking sector is critically important in its own right. The fact is also that each of the two mega-banks - let alone the two combined - would be vastly larger than any institution even in the broader sector to which they refer. They would, by any definition, be dominant.

The inevitable effect would be a drastic reduction in competition.

The merger-seeking banks have argued that competition would be maintained because other institutions, particularly foreign banks and monolines, would increase their presence.

There is no evidence to support this contention. In fact, the argument appears contradictory, because the merger-seeking banks have said that a key reason for the proposed mergers is to prevent new competitors such as a monolines from eroding their market share. If the mergers achieved this objective, then obviously the new competitors would not be a significant force in the market for long.

A more realistic view, in any event, is that the "secondary market" of alternative financial institutions would remain under-developed, as it is at present. If such institutions have failed to win significant market share from the banking sector as currently structured, it is difficult to see why they would fare better against the market power of two behemoths.

As Hon. Henry N.R. (Hal) Jackman, chairman of E-L Financial Corporation, stated: "The mergers have as their sole purpose the desire to lessen domestic competition. By making just two banks stronger, they will more effectively be able to keep foreign competition out, thus lessening the choices to Canadian consumers and small business."²²

At present, the top of the Canadian banking sector consists of five large banks engaged in reasonably active competition with each other. The proposed mergers would eliminate two of those competitors outright, leaving

Canadians with two mega-banks and one much smaller large bank. By any conceivable definition, that would be a severe reduction in competition, contrary to the public interest.

The banking sector would be transformed into what economists call a dominant duopoly. And as leading economists Douglas Peters and Arthur Donner have pointed out: "Economic theory holds that a duopoly either implicitly or explicitly colludes, or competes to the death of the other player with the largest capitalised likely to win. Neither option would be palatable, but one might suggest that the first option would likely be the one chosen.."²³

The Caucus Task Force therefore finds:

Finding #6: The proposed mergers would adversely affect the public interest by making the Canadian banking sector the most highly concentrated in the industrialised world, with a resulting significant decrease in competition.

3.2 Higher Costs and Reduced Consumer Choice

While the merger-seeking banks say that efficiencies arising from the mergers should bring lower costs for customers, all the empirical evidence is to the contrary. Bank consolidations tend to result in increased fees, reduced service and diminished choice for customers.

For instance, Mary Griffin, counsel for Consumers Union Inc. of New York which publishes Consumer Reports, points out that numerous U.S. studies have shown that banks charge higher fees as they get larger.²⁴

Addressing the Canadian context, National Bank Chairman Andre Berard told the National Caucus Task Force: "Let's be frank - if you have no competition, why would you drive prices down?" He suggested that the likelier game plan is to consolidate, force others out of business, and then raise prices.

The reason that Canadian bank service charges and interest rate spreads are relatively low at present is that the major banks are engaged in reasonably active competition with each other in the large urban centres, particularly Toronto. If that competition is significantly reduced through the disappearance of two banks and equilibrium is established, costs are bound to start creeping up.

As economist Bruce Whitestone put it: "Inevitably new and higher fees will be charged to customers, branch offices shuttered, and a decrease in traditional service at tellers, all will make customers feel neglected."25

No less worrisome is the observed tendency of big consolidated banks in the U.S. not to want to bother any longer with smaller, moderate- or low-income customers, preferring to focus on the most affluent. This phenomenon is described by Charles B. Wendel, president of Financial Institutions Consulting in New York: "Consolidation is good for customers who are attractive to financial services companies, because more people are going to focus on that customer. Those who might not fare so well will be mass-market customers below them, because...they will be 'fee'ed' to death."²⁶

There is no reason for optimism that merged mega-banks would not adopt the same approach in Canada, since our banks are already well aware of the segmentation of their customers. Complaining about the threat of cherry-picking by competitors, TD Bank Vice Chairman Robert Kelly recently wrote: "There is an old adage in retail banking called the 80/20 rule. Basically, 80% of customers are unprofitable. The other 20% of customers are profitable and carry the other 80%."²⁷

If the proposed mergers take place, customers encountering unfavourable treatment on this basis - or otherwise dissatisfied with service - would have a sharply reduced choice of alternatives. At present, a customer wanting to change banks but remain with one of the major institutions has a choice of four others, at least in the major urban centres. After the merger, there would be only two others to choose from. In rural areas, of course, the choice would be even more limited, if any existed at all.

The Consumers Association of Canada has taken the position that more consolidation in the banking industry can only be harmful to consumers.

Spokesperson Tom Delaney stated: "I don't see how it's going to be of benefit to consumers - how can it be?"²⁸

Also TD Bank Chairman Charles Baillie acknowledged to the National Caucus Task Force that "consumers and business borrowers are better off with banks as they are now." He contended that mergers are nevertheless inevitable, but that is a different matter.

Based on the information available, there clearly appears sufficient reason for concern that by reducing competition, the proposed mergers would likely be detrimental to consumers.

The National Caucus Task Force therefore finds:

Finding #7: The proposed mergers would be likely to adversely affect the public interest by leading to higher banking costs for Canadians and reducing consumer choice.

3.3 Branch Closings

An inevitable consequence of the mergers would be branch closings, both in urban centres and in rural communities. Since the whole logic of merging is to integrate and rationalise services, each merger would be likely to cause the disappearance of a branch nearly everywhere that merging banks overlap.

The chairmen of BMO and Royal Bank have said they would ensure that the merger of their banks did not leave any community they are currently serving without any bank service at all. CIBC Chairman Al Flood told the Caucus Task Force, however, that he has to "look in the mirror every day" and therefore could not make a similar undertaking on behalf of the CIBC/TD Bank merger.

Bank of Montreal Chairman Matthew Barrett has said that the merger of his bank and the Royal would, in fact, lead to an increase in the number of branches. But this appears to be a matter of semantics, since Mr. Barrett acknowledged that not all of them "will be branches as we have traditionally known them."

A "branch" that consists of a corner of a rural post office - or perhaps of an ATM, a computer terminal and a direct telephone line in some nook of a store or post office - is scarcely comparable to a full-service bank branch fully integrated into a community. For a great many customers, it cannot take the place of negotiating a mortgage or arranging some change in service with a bank manager with whom day-to-day contact has been established. It would defy logic to believe that the merging banks would not make every possible effort to maximise branch closings and eliminate duplication, since consolidation of branches and head offices is where the principal purported cost advantages of merger lie.

The inescapable reality is that the wave of branch closings that would result from the mergers would be likely to significantly reduce choice, service and convenience of access for many Canadians--particularly in rural or remote areas.

For instance, TD Bank Chairman Charles Baillie told the National Caucus Task Force: "We simply don't need to occupy two corners of every major intersection in our large cities." But it is reasonable to assume that the TD Bank and CIBC branches on opposite corners of any given intersection are both busy, fully utilising their available space and personnel, or they would have been closed or downsized independent of any merger. That suggests that closing one branch and effectively doubling the customer load of the other would mean longer line-ups, greater delays, crowding and diminished service, since doubling the space and staff would defeat the purpose of rationalising.

In smaller communities, the impact of branch closings would be even worse, in many instances halving the number of banks available, and leaving some communities with only one bank or even none.

Contrary to what the merging-seeking banks suggest, electronic banking in its various forms could not fully fill the void created by branch closings, both because many customers do not have access to the technology and because many - particularly among older Canadians - would not be comfortable using it.

An additional consideration is the effect that large-scale branch closings and head office consolidations could have on real estate markets and municipal property tax revenues. Particularly if implementation of the mergers coincided with an economic downturn, property owners could find themselves with vacated premises they were unable to fill, while a resulting decline in municipal tax revenues could shift the tax burden onto other businesses.

The National Caucus Task Force therefore finds:

Finding #8: The proposed bank mergers would be likely to adversely affect the public interest by precipitating large-scale branch closings in due course.

3.4 Impact on Businesses

The proposed mergers are opposed, or viewed with grave concern, by business groups including the Canadian Federation of Independent Business, the Alliance of Manufacturers and Exporters, and the Retail Council of Canada.

The merger-seeking banks say that the mergers would enable them to provide improved services to the business community, particularly small and medium-sized enterprises, but this claim is received with skepticism by the businesses themselves.

The banks have consistently claimed that the reason they don't do more lending to small and medium-sized businesses is not lack of capital, but difficulty in finding businesses that qualify. It is unclear therefore, why the mergers would improve the performance of the banks in this regard.

It is likely that the quality of service to, and number of options for, small and medium-sized enterprises would be more likely to decline if the proposed mergers are approved.

Businesses would have two fewer banks to approach for financing. It is not uncommon for some small or medium-sized businesses to unsuccessfully seek loans from four banks and finally succeed with a fifth, so a 40% reduction in potential sources of funding would be a serious blow. Similarly, businesses unsatisfied with their banking relationships would have two fewer alternatives to explore.

In smaller communities, options would be even more severely limited by the mergers, forcing businesses in some cases to deal with only one bank - or, even worse, requiring them to rely on dealing with bank management in another city in a relationship not based on personal knowledge of them or their communities.

Scotiabank Chairman Peter Godsoe told the National Caucus Task Force: "Technology is not the answer for small business, especially when you consider about two-thirds of small business customers don't use the Internet, and won't be able to use alternate delivery channels when branches close down."

There is also valid cause to fear that the merged mega-banks, by virtue of their enlarged size and scale of operations, would be even more reluctant than today's individual banks to bother with comparatively small loans to small and medium-sized businesses.

There is a risk, as well, that businesses would find their financing reduced if they were in relationships with two merging banks. If a company had lines of credit of $500,000 each with Royal Bank and BMO, for instance, it is unlikely it would end up with a $1 million line of credit from the new merged entity. The way risk management by banks tends to work, it would probably have to settle for perhaps $750,000 in total.

The most recent poll of its membership by the Canadian Federation of Independent Business found that 68% oppose the mergers. Among firms with four employees or less, which comprise 78% of Canadian business establishments, opposition to the proposed mergers was even higher, at 72%.

CFIB Vice-President Garth White told the National Caucus Task Force that his organisation has met with the heads of the banks and "in our meetings CFIB representatives heard nothing to give us any confidence that the proposed mergers would be a positive force for small business, jobs or the economy as a whole...What is most disturbing is that in our meetings with several bank CEOs it was acknowledged that small and medium-sized businesses would be among the most vulnerable in terms of negative impacts were the mergers to proceed."²⁹

The same point is made by the Catherine Swift, President of the Canadian Federation of Independent Business: "Even the heads of the merging banks are saying, 'Yes, you're right. You are the most vulnerable constituency.'"³⁰

There is no persuasive evidence to indicate that the concerns of small and medium-sized businesses are in any way exaggerated.

Therefore the National Caucus Task Force finds:

Finding #9: The proposed mergers would be likely to adversely affect the public interest by being harmful to small and medium-sized Canadian businesses.

3.5 Effect on Rural Communities

It is important to note that any adverse effects of the proposed mergers outlined above would be even greater for individuals and businesses in rural communities.

The banks play a particularly important role at the hub of day-to-day life in those communities. In most instances, two or sometimes three of the five major banks are present in any given community. Closing or consolidation of branches due to mergers would therefore restrict choice and reduce access to services even more drastically than in urban centres.

The impact would be further magnified by the fact that secondary-market financial institutions, to which the merger-seeking banks point as alternative sources of competition, have very little presence in smaller communities, except for credit unions in British Columbia and Saskatchewan and caisses populaires in Quebec.

The result of the mergers, consequently, would be to aggravate the disadvantage at which individuals and businesses in smaller communities already find themselves with regard to financial services.

Canadian Federation of Independent Business President Catherine Swift stated: "We see already, where there are only two institutions in a community, higher service charges, higher collateral demands, higher interest rate charges and less access to credit. They charge what the market will bear. When there's only one game or a couple of games in town, the sky's the limit."31

The National Caucus Task Force therefore finds:

Finding #10: The proposed mergers would be likely to adversely affect the

public interest by disproportionately reducing the access of individuals

and businesses in smaller communities to competitive banking services.


3.6 Job Losses

Bank of Montreal Chairman Matthew Barrett told the National Caucus Task Force that approximately 9,000 jobs would be lost in the proposed merger between BMO and Royal Bank, but that this would be done mostly by attrition. Royal Bank Chairman John Cleghorn told us that actual involuntary departures as a result of the merger would be "minimal."

Similarly, TD Bank Chairman Charles Baillie said there would be "some minimal layoffs" in a TD/CIBC merger, and referred to a combined annual attrition rate of about 8,000 in the two banks. CIBC Chairman Al Flood told us that he could not guarantee there would be no outright job losses, but that the bank would try to be sensitive.

Even if one accepted that all the reductions in both mergers would be made by attrition, that would still mean the elimination in total of some 17,000 jobs. And a job lost by attrition is still a lost job - it's one job less that is available in the Canadian economy.

There is reason to be concerned, however, that these numbers may be too conservative and that the two mergers would in reality lead to very substantial, even massive, layoffs.

Based on the results of other similar mergers, Douglas Peters and Arthur Donner estimate likely staff reductions of 20,000 to 40,000.³²

National Bank Chairman Andre Berard told the National Caucus Task Force: "I have done eight mergers at BNC, and have yet to see one that doesn't result in job loss. Staff redundancies and branch closings are inevitable. They will not be able to deal with redundancies solely by attrition."

Last January, before his own bank opted for a merger, TD Chairman Baillie was publicly sceptical of the Royal Bank's and Bank of Montreal's claim that job losses from their merger would be minimal: "Our analysis shows if we were to combine with someone, there would be severe job losses, as there have been in the U.S."³³

In addition to potentially huge job losses at the merging banks themselves, there would also likely be a ripple effect of job losses elsewhere in the economy.

For instance, advertising agencies, market research firms and law firms and other service suppliers would be likely to lose business as the merging banks combined their operations.

The merger-seeking banks have provided no persuasive evidence or details to substantiate their claims that job losses on such a large scale would eventually be offset by employment gains resulting from the mergers.

The National Caucus Task Force therefore finds:

Finding #11: The proposed mergers are likely to adversely affect the public interest by resulting in large-scale job losses in the Canadian economy.

3.7 Risk of Systemic Failure

While Canada currently has a strong and stable banking sector, the experience of other countries - including Japan, France, the U.K. and the U.S. - has clearly shown that even seemingly invincible banks can sometimes get into trouble and fail. In the Canadian context, it is worth remembering in this regard that in the 1980s our insurance companies ran ads saying that no Canadian insurance company had ever failed - then in the 1990s we had the failure of Confederation Life. It would not be sound strategic thinking to base public policy on the assumption that bank failure couldn't possibly happen here, under any circumstances.

There is legitimate cause for concern that the proposed mergers would increase the risks for Canada in this regard.

First of all, size can lead to hubris. Bigger banks - particularly bigger banks that attained their behemoth size in stated pursuit of international glory -tend to take bigger risks. As well, consolidation would by its very nature nearly double the value of the assets ultimately dependent on the soundness of judgement of a single CEO. It stands to reason that, to one extent or another, this increases the risk of possible failure.

What is even greater cause for concern is the degree to which the proposed mergers would raise the stakes for our banking system and for Canada as a whole, by hugely magnifying the consequences of any failure.

When a bank fails, it is usually possible to recover roughly 85% to 90% of its assets. This means that if a bank with assets in the range of $200 billion were ever to fail and 10% could not be recovered, the system would have to come up with $20 billion to cover the loss and regain stability - a huge amount, but manageable.

But if a bank with assets of $450 billion - the approximate range of the proposed mega-banks - ever failed and, say, $60 billion had to be covered, that would not only be beyond the resources of the banking system but would severely strain the capacity of the federal Government. There would be a real risk that the whole banking system could fail.

It is important to emphasise that this is only a worst-case scenario. All our banks are prudently managed and stringently supervised, and would likely remain that way even after mergers. But a significant increase in the risk, and the consequences, of a failure has to be weighed as one of the adverse effects of the proposed mergers.

This issue will be addressed in detail by the Superintendent of Financial Institutions, who will provide advice to the Minister as to the extent of systemic risk.

The National Caucus Task Force therefore finds:

Finding #12: The proposed mergers would be likely to adversely affect the public interest to the extent that if a bank failure occured, it is more likely to cause systemic failure in the Canadian banking system.

3.8 Excessive Concentration of Political Power

By the nature of their role in the Canadian economy and Canadian society, the major banks and their chairmen have considerable political clout.

But that clout is diffused among five major institutions and five CEOs who do not always agree among themselves, so no single institution or individual wields grossly disproportionate political power. That is why the banks currently remain subject not only to Government regulation but also to "moral suasion" on the part of the federal Government, for instance on matters like their treatment of small business.

But if the proposed mergers were allowed to create a situation where two banks and their chairmen effectively dominated the entire banking system, controlling more than 70% of total domestic assets, that would risk establishing a very different dynamic. It is no exaggeration to say that if the two behemoth banks agreed on something between themselves, they might well have the economic power - and therefore the political power - to resist the economic policies of the federal Government and pursue whatever course they wished.

This concern is not eliminated by our confidence that no current CEO of any of the major banks would behave in such a fashion. The point is simply that it is not in the public interest to create such a massive concentration of power in a key sector of the economy that it would have the capacity, even hypothetically, to impose its will on the democratically elected authority.

The National Caucus Task Force therefore finds:

Finding #13: The proposed mergers would be likely to adversely affect the public interest by excessively concentrating economic and political power in the two merged entities.

3.9 Conclusions Regarding Possible Adverse Consequences

The National Caucus Task Force was struck by the number and the intensity of concerns that were brought to our attention regarding the proposed mergers.

Even more striking was the diversity of the organisations and individuals who detailed their conviction that the proposed mergers would adversely affect the public interest. They ranged from representatives of business to representatives of consumers, from self-described conservatives to liberal activists.

In the course of the National Caucus Task Force hearings and research, representatives of the merger-seeking banks were afforded every opportunity to refute the purported adverse consequences put forward. Regrettably, they were unable to establish persuasively that the concerns were ill-founded.

The overwhelming weight of evidence and expert opinion heard by the Task Force is that the proposed mergers would: excessively concentrate the Canadian banking sector, diminish competition; impose higher service charges and borrowing costs, and reduced choice, on individual customers; result in extensive branch closings; reduce access to credit and services for businesses, particularly small and medium-sized enterprises; reduce service to rural communities; cause large-scale job losses; increase the risk of system failure in the Canadian banking system; and excessively concentrate economic and political power in the two merged entities.

The National Caucus Task Force therefore finds:

Finding #14: There is persuasive evidence that the proposed mergers would be likely to have very adverse consequences for the Canadian public interest.

4.0 CONCLUSIONS AND RECOMMENDATION

In applying the test of costs and benefits to the proposed mergers, the Caucus Task Force has found that they fall into the third of the four possible categories cited at the outset of this report:

The purported benefits to the public interest have not been substantiated, while the adverse consequences are likely to be very significant. The mergers as proposed therefore appear to be contrary to the public interest.

Faced with this situation, the Minister of Finance and the Government have three possible courses of action:

i) approve the proposed mergers regardless.

ii) approve the mergers with conditions.

iii) decline to approve the mergers.

4.1 Approving the Mergers

To approve the mergers under the circumstances identified would be to disregard the very legitimate and substantiated concerns of a wide cross-section of the Canadian public, as well as strong evidence that these mergers would likely be contrary to the public interest.

Taking such a course would be justified only if it were necessary due to some other, overriding considerations. We have not identified any such considerations.

Therefore, the National Caucus Task Force is unable to recommend approving the proposed mergers.

4.2 Approving the Mergers with Conditions

It would be tempting to find a middle ground between approval and rejection, in the form of approval with conditions to ensure that the public interest is not adversely affected.

Such an approach might make sense if the proposed mergers were likely to bring significant benefits to the Canadian public interest, but had a few possible adverse consequences that might be mitigated by conditions.

The findings of the National Caucus Task Force are, however, that the proposed mergers are unlikely to bring any significant benefits. No conditions the Government might impose can change that. The Government cannot "order" economies of scale to exist where they do not, for instance, or bigness to make the banks more internationally competitive if it does not.

Conditions might, in theory, mitigate some of the likely adverse consequences of mergers. But in this instance, it is difficult to conceive that merger conditions could prevent them all.

The Minister and the Government hypothetically might set conditions, for instance, with regard to service charges, branch closings or job losses. But certain problems do not appear capable of being addressed by conditions, whether it be excessive concentration and reduction of competition, increased risk of systemic failure, or concentration of economic and political power.

An even more fundamental obstacle is that it would make no sense to set conditions which would violate the whole logic of the mergers. Telling the banks, for instance, that they can merge but cannot rationalise their distribution network through branch closings or their personnel through layoffs, for instance, would be likely to make the mergers inefficient and largely pointless.

It would not be sound public policy to permit a course of action subject to conditions which are likely to make it unsuccessful.

Finally, and no less fundamentally, the difficulty with conditions is that they would be unenforceable.

Conditions cannot be imposed for all time. Even if some conditions attempted to protect the public interest they could only be imposed for perhaps five years. At the end of any such period, the same adverse consequences would still occur. Delaying harm to the public interest would not constitute protecting the public interest.

Even during a limited time span it would be difficult to enforce any conditions that might be imposed.

The merged banks might argue in a year or two, for instance, that charges must be increased, branches closed and/or staff laid off - not due to the mergers, but to unforeseen market changes or external circumstances. They might argue that they must take certain actions or become uncompetitive or financially troubled.

What would the Government do then? Could it order them to undo the mergers as a penalty for breaching the conditions? Could it pass legislation ordering them to maintain a course that might be contrary to sound business practice and lead to unsatisfactory financial performance? Neither option, obviously, would realistically exist.

Under the circumstances identified, approving the mergers with conditions would be tantamount to approving the mergers outright without effectively protecting the public interest.

4.3 Declining to Approve the Mergers

The Minister of Finance has full discretion to decline approval of the proposed mergers.

The National Caucus Task Force has carefully reviewed whether any significant adverse consequences would be likely to result from turning down the proposed mergers. We find no such risk.

Share prices of the merger-seeking banks rose dramatically following the announcement of the proposed mergers, but they have since adjusted back to pre-merger-announcement levels. It would strain credulity to believe that the stock markets have not already factored in the realisation that approval of these mergers is far from being a foregone conclusion.

The merger-seeking banks have delivered veiled threats that refusal to permit the mergers might cause them to engage in large-scale branch closings or to withdraw from offering certain services.

But the banks have in any event been closing branches they find unprofitable, and in the normal course of events the proposed mergers would lead to far more - not fewer- closings. Likewise, we cannot envisage the banks withdrawing from profitable activities in the absence of a merger, nor remaining in any activities they found unprofitable even if the mergers were approved.

There also is no cause for concern that declining the mergers would somehow cause Canada to be negatively perceived internationally. Both Australia and the United Kingdom have recently refused to permit bank mergers that would lead to high levels of concentration. Since it is highly unlikely that the government of any other industrialised country would permit the degree of concentration these two proposed mergers would bring, the Government would merely be perceived as meeting its responsibilities in declining them.

The National Caucus Task Force is aware that a decision to decline approval to the proposed mergers would be a difficult one. No Minister of Finance and no Government would want to go down in history as having made the decision that led over time to a weakening of the Canadian banking system.

But the National Caucus Task Force is convinced that the risk of this is far greater if the mergers are approved than if they are declined.

There is no evidence that the mergers are necessary under present circumstances, nor that they would be beneficial. There is considerable evidence that under present circumstances they would be detrimental to the public interest.

Circumstances can change, of course. If in five or 10 years circumstances we do not currently foresee were such that mergers appeared likely to benefit the public interest, merger-seeking banks could approach the Government of the day and state their case.

On the other hand, if the proposed mergers were approved now and did indeed prove harmful to the public interest, there would be no realistic way to remedy the error. As Competition Bureau Director Conrad von Finckenstein recently stated: "As we say in competition, once you let something go together, it's very hard to unscramble the eggs."34

It is important to note, too, that these merger proposals have virtually no constituency of support beyond the merger-seeking banks - and even two of those, the TD Bank and CIBC, appear to us to be lukewarm and belated in their enthusiasm.

The proposed mergers are opposed by such groups as the Canadian Federation of Independent Business, the Alliance of Manufacturers and Exporters of Canada, the Retail Council of Canada, the Consumers Association of Canada and the Canadian Association of Retired Persons, to name only a few. The Business Council on National Issues, which is usually vocal in support of any big-business initiative, has been conspicuously silent.

Among individual opponents of the proposed mergers are many who cannot be conceivably characterised as anti-business or left-wing, including Marcel Côte, a former top advisor to Prime Minister Brian Mulroney; former Progressive Conservative minister Sinclair Stevens; Hon. Hal Jackman; Adam Zimmerman; and Professor John Crispo.

The Task Force has not been provided with any good reason to approve these mergers, beyond the fact that two major banks - the Royal Bank and Bank of Montreal - aggressively want it, without having successfully made a persuasive case on the merits. That is not sufficient cause, in our view.

As Globe and Mail columnist Jeffrey Simpson has written: "Banks are not like widget-makers or steel producers. They exist in every Canadian town, touch millions of households and businesses, employ tens of thousands of people, handle billions of dollars in transactions. They have already been allowed to grow bigger within Canada by gobbling up brokerage houses, selling certain kinds of insurance, snapping up trust companies. They are, for domestic purposes, plenty large. Something even larger is at stake, something that cannot be accounted for by bottom-line accounting or conventional economic analysis - a sense among ordinary people that they have lost some measure of control over their lives and their country."³⁵

Proponents of the merger were given a full opportunity to make their case for the merger through both oral and written submissions. They have failed to do so.

The Minister of Finance will be receiving reports from the Competition Bureau, OSFI, and his department, which are not yet available to us. The conclusions of these reports need to be considered before the government can make a decision. However, based on our work, as well as the thoughtful input we have received from so many concerned Canadian individuals and organisations, the National Caucus Task Force recommends: ATION # 1

That the Minister of Finance not approve the proposed bank mergers.

_________________________

1. Executive summary of submission to Task Force on the Future of the Canadian Financial Services Sector.

2. Letter of June 16, 1998, to Tom Kierans, president of the C.D. Howe Institute, copied to Tony Ianno, Chairman of the National Liberal Caucus Task Force on Financial Institutions.

3. Report of the Task Force on the Future of the Canadian Financial Services Sector, pages 161 and 166.

4. TD Bank Financial Group, Information on the Canadian Financial Services Industry; August, 1998

5. Report of the Task Force on the Future of the Canadian Financial Services Sector; page 123

6. Charles Freedman and Clyde Goodlet, Bank of Canada Technical Report #82; October 3- 5, 1997.

7. Address to shareholders, Royal Bank Annual Meeting, March 5, 1998

8. Letter to Tony Ianno, M.P.; September 14, 1998

9. Ingo Walter, in Financial Markets, Institutions and Instruments; Salomon Centre, New York University, 1997.

10. Stephen A. Rhoades, Staff Study 167, Board of Governors of the Federal Reserve System; July, 1994.

11. Herwig Langohr, "Big is not best in Euroland," The Banker; January, 1998.

12. Eric Reguly, "Mergermania: Bigger is not necessarily better," The Globe and Mail; April 14, 1998.

13. Quoted in The Financial Post, "Diseconomies of scale," January 31-February 2, 1998

14. Quoted in The Financial Post, "OSFI head says merger could weaken Royal, B of M," March 24, 1998

15. Task Force on the Future of the Canadian Financial Services Sector, Background Paper #1, page 114.

16. ibid., page 112.

17. Report of the Task Force on the Future of the Canadian Financial Services Sector, page 112

18. John W. Milligan, "Are mega-banks good for America?", US Banker; June, 1998

19. World Economic Forum, The Global Competitiveness Report, 1997; page 246

20. Quoted in The Toronto Star, "Bank merger not needed says Manulife president," March 27, 1998.

21. Quoted in The Ottawa Citizen, "Banks are never too big to fail, Thiessen warns," April 24, 1998.

22. Address to Annual Meeting of Shareholders, April 24, 1998

23. Douglas D. Peters and Arthur W. Donner, "Bank Mergers: The Public Policy Challenge,"

September 12, 1998; page 7

24. The Financial Post, "In banking, bigger isn't necessarily better," January 29, 1998.

25. Bruce Whitestone, "Mergers in the Financial Industry," June, 1998.

26. Quoted in USBanker, "Are Mega-Banks Good For America?" June, 1998, page35.

27. Letter to Tony Ianno, M.P., September 14, 1998.

28. Quoted in The Toronto Star, "Small business fights bank mergers," April 21, 1998

29. Letter to Tony Ianno, M.P., September 4, 1998

30. The Globe and Mail., "Small firms step up bank merger fight," August 27, 1998.

31. The Toronto Star, "Small-town businesses fear loss of choice," April 4, 1998

32. Douglas D. Peters and Arthur W. Donner, op.cit., page 7

33. Quoted in The Financial Post, "Merger," January 24, 1998

34. CBC interview with Don Newman, May 6, 1998.

35. Jeffrey Simpson, "Bank merger mania means a giant Bronx cheer for Canadians," The Globe and Mail, April 21, 1998