Tuesday June 19, 2001
President & Chief Operating Officer
TD Bank Financial Group
Canadian Competition Policy Conference.
June 19, 2001
Thank you Joe
My topic in your agenda is the challenge of deregulation for competition policy. I plan to focus on the financial services industry, since that's the one I'm most familiar with. But my challenge is that financial services is one of the most regulated sectors in the country. Had I stuck strictly to the topic we could have finished lunch in just a few minutes. So I hope you will not be too disappointed that I have chosen instead to look at the dynamic between domestic competition and international competitiveness from my vantage point at TD Bank Financial Group.
Even then, I may disappoint some of you. Given the fact that Bill C8, the new financial services legislation, has just been given royal assent, some of you may be expecting me to make an announcement about TD Bank's future intentions. All I can say is -- relax and have another cup of coffee. I am simply here to contribute to the discussion.
My focus on financial services does not imply that I am making a case for mergers, nor that I see mergers soon. I'm not jumping out of the starter's block. I'm sure that my stating that so unequivocally up front won't stop the tealeaf reading. But I would offer my perspective, that contrary to all the reports of mergers happening tomorrow, I think we are just beginning the process of building consensus on the issue, not concluding it.
So I will begin by talking about competition in our domestic banking market. Then I'll talk about international competitiveness, and finally I'll look at the dynamic between them. I believe that it's this very dynamic - between domestic competition and international competitiveness - that makes it such a challenge for politicians, regulators, competition authorities, business leaders and consumers, to chart the right course. I certainly don't presume that I have all the answers - but I hope that the perspective of a business leader within an industry grappling with this dynamic today might be useful in the context of your overall discussion.
As I mentioned at the outset, the financial services sector is one of the most regulated areas of the Canadian economy. Primarily we are regulated for safety and soundness, and the protection of consumers' deposits. We are overseen by OSFI, CDIC, and, soon, we'll have the Financial Consumer Agency of Canada. Every province has its own securities commission. So we don't lack for regulations. And now Bill C-8 adds the Public Interest Review Process in the event of a proposed merger. The regulations are becoming broader, more complex and more comprehensive.
That said, there has been some deregulation in our industry. The traditional four pillars of financial services were broken down in the 1980s. This allowed banks, trusts, loan and insurance companies, credit unions and mutual fund companies to compete relatively freely in each other's areas of business. The two notable exceptions to deregulation are the right of banks to sell insurance through their branches and to be involved in auto leasing. Canada's major banks believe that consumers would be better served and have lower prices if we were allowed to compete in these markets. But this is a debate I'll leave for another time.
For the purposes of today's discussion, I'm talking about universal, or full service banks-in Canada that means the Big Six banks- TD, Royal Bank, CIBC, Bank of Montreal, Bank of Nova Scotia and National. I'm not speaking for any of the other big banks here, but we all face the same issues.
In universal banking there are three distinct areas of business: first, retail banking; second, small business and commercial lending; and third, corporate and investment banking.
The retail side can be divided into two parts. One part is basic or core banking, which is non-term deposits, and savings and chequing accounts These activities are carried out primarily through branches, and increasingly through electronic channels. The second part of the retail side is made up of other financial products and services like mutual funds, credit cards and mortgages. But here non-bank branch distribution systems significantly reduce competitive concerns.
In core banking the advantage is clearly with the first players in the market. The big six banks are the major players in this business. We have seen growth in other non-traditional providers, like President's Choice Financial at Loblaws, and electronic competition from foreign institutions like ING, although they haven't fully matured yet.
There are also important regional differences. In Quebec and the West, credit unions provide a significant measure of competition. With the new legislation allowing mutual funds, brokers and life insurers access to the payments system, more entities can now accept deposits and competition will likely grow.
In addition, community banks and closely held banks are now permitted. Less capital is required to set up shop. These measures bring in more providers of basic banking services and should mean better deals for Canadian consumers.
All of this will soon change the perception - perhaps even induce a redefinition - of competition in banking. But for the moment, the Competition Bureau sees a risk of excessive concentration and has issued guidelines to its approach to merger review. Taken together, these guidelines may imply that there should be at least three national banks, and possibly four. Put another way, even if there are mergers, Canadians may have at least three to four large players, in addition to the many smaller players that exist today.
It may be counter-intuitive to some, but in fact the Canadian banks' position in core banking has not harmed consumer value. When you have a few large players, competition is fierce.
Every study I've seen suggests that Canadian banks not only have lower average fees, but more importantly, we have a narrower spread on loans than in the United States. The skills we've developed will be useful to us, and to consumers, as we compete abroad.
In non-core banking, competition is along product, rather than institutional lines. Today, we compete with new product specialists, many foreign owned. In credit cards, we compete against MBNA, Capital One and CitiCorp. They have a huge competitive advantage over us because their success depends on an infrastructure that is hard to achieve with Canadian scale.
Mutual funds are the same. Mutual fund assets of the Big Six banks represent less than 30% of the mutual fund industry. Mutual fund sales are dominated by financial planners. This is a channel where the banks are minor players. This is important, because while competition guidelines focus on core banking, mutual funds are taking a larger and larger share of personal deposits.
In brokerage we compete against the likes of Merrill Lynch and Schwab. And in the mortgage business there is a growing shift to the mortgage broker market, where price competition is fierce. From the perspective of competitive choice, consumers of these products are being very well served today.
Small Business and Commercial Lending
The second area in domestic financial services that has been a focus of the Competition Bureau is banking for small and medium-sized businesses, particularly lending. The key issue here is choice.
We must and we will, serve this sector. It is important to us and it is important to the country. Banks have listened to legitimate concerns that came out of the last market downturn and we have all stepped up our efforts in this area. Certainly TD is not ignoring it. Since our acquisition of Canada Trust, we have grown our share of small business lending in the last 12 months alone. Such growth is not a typical outcome of a merger, so you can see we are committed to aggressively growing our small business lending. A whole series of small and mid-market lending specialists like Wells Fargo and Merrill Lynch are coming into this market and leasing companies are taking a share too.
Corporate Lending and Investment Banking
In the third area of banking, corporate lending and investment banking, size and scale are increasingly important. Global consolidation is taking place, while financing requirements are growing apace. Here in Canada, large Canadian corporations require access to global-scale providers of financing.
In transactions of this nature, size matters, borders don't. You can't be part of the financing if you don't have the capacity to take a large position in underwriting, syndications and new issues. It is illustrative that in the recent takeover of Gulf Canada by Conoco, there were no Canadian financial firms in the transaction. All the money to be made in advising on and financing the purchase will go directly to the United States. And look at Domtar's recent acquisition. All foreign advisors.
It is no longer possible for Canadian banks to be universal corporate players at the global level. So we have found a different way of competing. All Canadian banks now run more focused strategies. We have to determine -- where are the places in the world where massive scale is not a critical factor? Where can we build specialist expertise so that we can compete? How can we capitalize on our more local knowledge of the issues? And what size do we need to successfully implement even those more modest ambitions?
At TD we specialize in media and telecommunications and are one of the world's leading banks in lending, capital markets underwriting and financial advice in these industries. We are a leading participant in derivative markets in the United States and Europe, and our acquisition of Newcrest in 2000 gives us increased strength in institutional equities and investment banking.
All Canadian banks also need to have strategies at home to help small to mid-sized businesses grow and become internationally competitive. We recognize that once they reach a certain size these businesses may also turn to the services of the big global players. But we can hope that the relationship we've built up, and our understanding of their business, will give us an edge on our mega-competitors and make us lasting partners as they grow.
Impact of Globalization
We are going through a period of intense worldwide consolidation in financial services. Mergers and acquisitions are happening at a rapid pace, not just in the US where the market is more fragmented, but also in Europe following the introduction of the euro.
The world has moved on even since the 1998 merger discussions. Just three years ago, the dominant North American banks were significant players in wholesale and investment banking like Bank of America and Chase Manhattan. On the retailing side you also had dominant monolines -- single product players like Schwab in discount brokerage, MBNA in credit cards and Fidelity in mutual funds.
In the last three years we have seen the rise of the giant retail banks-Wells Fargo, Bank One and Fleet Boston. So our small size is becoming an issue in retail as well. Today, even if TD were to merge with any one of the big six Canadian banks we wouldn't figure in the top 10 in the world. Remember, these giants became big, not through internal growth, but through mergers and acquisitions.
What has stopped Canadian financial institutions from growing in the same way as their international competitors? In the last debate, many argued that Canadian banks lacked the drive to go abroad. In fact we have recognized the need to be Canadian champions abroad. We have all made substantial efforts to grow through acquisition. TD has TD Waterhouse in the United States, Australia and the United Kingdom, Royal Bank has made several acquisitions in the United States, Bank of Nova Scotia is growing in Latin America, Bank of Montreal has Harris Bank in Chicago, and CIBC has Oppenheimer and created Amicus.
On the retail side, size helps you take bigger operational risks, market more aggressively and invest more in technology. That in turn protects your capacity to compete at home and abroad. On the wholesale side, a large capital base is essential even for focused players like TD Bank.
Domestic Competition and International Competitiveness
This brings me to my key point, the dynamic between domestic competition and international competitiveness.
If life were simple they would complement each other, but unfortunately the two are sometimes distinctly at odds. And when that's the case there is a real challenge for competition policy.
How much the two are at odds depends on the nature of the product and how naturally open competition is. No one sees a tension between domestic competition and international competitiveness in the software industry. It's a mobile industry that easily crosses borders. But such a tension may exist in something like the railways and the airlines. Some may argue that they display, to use an economic term, natural monopoly characteristics, because they have huge infrastructure costs, even in very large economies like the United States. No one is going to build another set of railway tracks across Canada so they can compete with CN. No one is going to create a new national bank branch network from scratch either. The economies of scale simply don't permit it.
Canadians worry about how to get the scale we need for international competitiveness while maintaining domestic competition. So they should. This is a dilemma for all small countries. We hear much from politicians and academics about competitiveness and our need for innovation to fuel the economy and create and keep jobs. The crux of the issue is - if our firms are successful and grow - do they become too big in a small country?
In wrestling with the issue as it relates to banking, different small countries have acted differently. Some, like the Netherlands, have opted for totally open competition. Others, like Australia, and recently at least, Canada, have opted to restrict bank mergers.
The European Community is dealing with it by trying to break down national barriers and create an open enough market to get the benefit of community-wide competition.
We Canadians are proud of our political independence, and the specific culture our unique history has fostered. But this sense of identity should not blind us to the fact that economically Canada is highly integrated with the United States. More than 45% of our economy depends on exports. Eighty six per cent of our exports go to the United States. We trade more into the United States than does California. The reality of free trade is that we have to consider our competitiveness from a North American perspective if we are to succeed economically.
A fundamental question has to be answered. Does Canada care if it has world competitive financial players, or does it want domestic-only Canadian banks with strong positions in retail banking and commercial lending, and a few niches in corporate banking?
Do we want national champions in financial services that aggressively go abroad, and if so, do we accept that we may need to tolerate greater domestic concentration to get there?
We need to determine the tradeoff between the size that may be required to be a world player, and the domestic market implications of having a very small number of large firms. If we don't support the creation of banks that can play a significant role on the world stage, do policymakers, business leaders and consumers fully understand what benefits they forgo?
Benefits to Canada
So, just what are those benefits?
I know that all too often, bankers come across as very self-serving when they talk about these benefits. They sound as if the benefits are reserved exclusively for bankers, and don't also benefit Canadian businesses, corporations and consumers. It's very clear that we need to reassure our customers that a globally capable financial services firm, based in Canada, can still deliver superior banking value for its customers at home.
More than just our own customers, I think a strong-Canadian-based financial institution would, in the long-term, expand job opportunities for Canadians. With head offices in Canada, these companies would staunch the flow of Head Office jobs to the United States that we've all witnessed in other industries. Much of the income generated would come back to Canada. The big six Canadian banks already generate 49% of their revenue outside Canada. But ninety percent of our employees are located in this country and 75% of the taxes we pay are paid domestically. The creation of international competitors headquartered in Canada would also mean more stability to the Canadian economy through diversification of a large sector.
Various studies have shown that there is a correlation between a strong financial industry and strong cities, and that large, internationally competitive banks can make substantial contributions to their home bases as well as their national economies in terms of revenues, employment and shareholder benefits. That's very important for Toronto and this city's future. And while talk of shareholder benefits smacks of self-interest, it should be remembered that roughly one out of every two working Canadians is a shareholder of Canadian banks, directly or through a pension plan, mutual funds or an RRSP.
Managing the dynamic
We are not starting from scratch in this discussion. Our current regulatory framework - through the new financial services legislation as well as the work done by the Competition Bureau when considering the previous merger proposals in 1998 - clearly seeks to manage the dynamic between domestic competition and international competitiveness.
A lot of thought and hard work has been put into creating a framework for considering bank merger proposals, which includes three core tests.
The first test is the need to meet the safety and soundness and consumer protection requirements of the Office of the Superintendent of Financial Institutions. We understand the rules and support them.
The second test is to meet the criteria of the Competition Bureau's merger review process. The guidelines for its approach to merger reviews make it clear what the test is for determining whether mergers are anti-competitive or not. This approach is designed to protect the interests of consumers - an entirely legitimate objective.
Decisions made today will have an impact for decades to come. Just as we can't limit our horizons to the 49th parallel, the Competition Bureau will need to look beyond the current two-year time frame in its merger review process and adapt as quickly as the market changes and new players emerge. Who is to say that consumer needs won't be served in a variety of forms not yet imagined? The aspirations of Microsoft, Sears, Canadian Tire, Loblaws, the insurance companies, and the impact of the growing acceptance of on-line banking could dramatically change the way the market operates in five or ten years. The Internet has already transformed our business.
But for the moment, the process and the rules are clear, and we can accept them. We know the guidelines and our experience with the Competition Bureau gives us confidence that they will be reasonably applied.
The Third Test
So this leaves the third test, the Public Interest Review Process or PIRP. This is an unprecedented type of review. No other industry that I'm aware of is put to such a test. I worry that the process at the moment is too open-ended. What is being reviewed exactly? We need to define its characteristics more closely, so businesses will know what the hurdles are.
The challenge here is to define clearly what the review process is intended to accomplish and to ensure that it does not undermine the integrity of the other two tests now in place. We cannot have two review processes for the same issue.
So, PIRP can't be about domestic competition, because the Competition Bureau already does that. It can't be about safety and soundness because OSFI takes care of that.
So, if a proposed merger meets the Competition Bureau and OSFI tests, that is, if it does not materially harm competition, and it creates a sound financial institution, what question remains for PIRP?
If we go back to the original government statement when the proposed mergers in 1998 were turned down, we can find a possible answer. There the government said it had three issues: safety and soundness, competition, and concentration of economic power. Since we now have rules for the first two concerns, and agencies to enforce and interpret these rules, then we must presume that the Public Interest Review Process is about the third concern: concentration of economic power.
If we want strong Canadian players, growing abroad, then what is the issue around concentration of economic power? In my view, it's partly about Canadians accepting the fact that, as a result of NAFTA, we are part of a North American economy. Indeed we have to think of ourselves as a large North American economic region. I emphasize economic region. I am not saying that we are or should be a political region of the United States. But we must look at ourselves in the same way as our competitors look at themselves.
If we are a part of a North American economy, with whom are we competing? And how do their regions regard the issue of "concentration of economic power" in their banks? Let's look at some of their super-regional banks.
Bank One has a market capitalization of $42 billion (U.S.) versus TD's market capitalization of $16 billion (U.S.), and is located in Chicago, Illinois. Illinois has a population that is 40% the size of Canada's. Do the citizens of Chicago want a growing and successful Bank One or do they worry about its power?
Fifth Third Bank is located in Cincinnati, Ohio. National City has its headquarters in Cleveland, Ohio. Together these two banks have a market capitalization of $51 billion (U.S.), more than 35% greater than the market capitalization of Royal Bank and TD combined. They are headquartered in a state whose population is 37% the size of Canada's. Do the citizens of Ohio want these firms to grow or are they worried they are already too big?
Charlotte, North Carolina, also has two big banks - Bank of America and First Union. Together their market capitalization is $128 billion, about twice the market capitalization of TD, the Royal Bank, Bank of Montreal and CIBC combined. North Carolina has a population smaller than Ontario's and less than 30% of Canada's. Do the people of Charlotte worry that their banks are too successful?
I don't need to beat this to death. But the examples go on - Fleet Boston in Boston, Wells Fargo in San Francisco, US Bancorp in Minneapolis, PNC in Pittsburgh -- all banks bigger than TD. All are located in cities that root for their banks, that hope they will grow and compete successfully in a consolidating financial services world. All are in cities that want to enjoy the benefits of the jobs these banks create and the taxes they contribute.
But Canadians, and the government we elect, worry about economic power. Why? Because, unlike those American states, they are not yet convinced that Canadians will be better off if we build large financial services companies, capable of competing in the world, and headquartered in Canada.
So we need to focus on what makes Canadians uneasy, and then clarify how the third test will address those issues. And we have to clarify this in a way that gives the banks clearer criteria by which they will be judged. If the way the rules are to be applied is not clear, businesses will not want to participate.
Let me try to set out two legitimate and important questions that policy makers and consumers should ask of Canadian banks. These may serve to give some boundaries to the PIRP and some direction to the banks as to what they have to do to address Canadians' unease about bigger banks.
The first question is -- In any proposed merger, will Canadian consumers be at least as well off as they are today? In other words, can you demonstrate that the merger will not be used as an excuse to take away things which consumers like, such as longer hours, friendly service and accessible credit? Canadians have one of the best banking deals in the world - will this continue if our banks get bigger?
The second question is -- In any proposed merger, over the long run, will Canadians, as economic citizens be at least as well off, as they are today? Will Canadian banks use their domestic strength to protect jobs in Canada which otherwise would have been transplanted to other countries? Do the banks have a clear business strategy to continue to grow abroad and in doing so generate economic benefits for Canada? Are they committed to using their strategic base to grow abroad in a way that creates jobs for Canadians? This seems to me the heart of the issue. Citizens of North Carolina support their banks' growth because they see it as being in their interest as economic citizens. They benefit from such growth. Canadians, too, have supported the rise of successful Canadian companies in other industries because we benefit from their growth.
If the banks are to have support for mergers, clearly we will have to convince Canadians that we care as much about our own customers' welfare as we care about our corporate and shareholder interests. We will have to convince them that we have aggressive plans to use our size to grow and create jobs for Canadians. We have not done well at this in the past. Previously, arguments in favour of consolidation were seen as very self-serving. Canadians did not see what was in it for them as either consumers or economic citizens.
We have learned a lot since 1998. The acquisition of Canada Trust by TD is a case in point. It undoubtedly is in our shareholders' interest, and has been a highly successful financial deal for TD Bank. But is there any value for consumers?
Right from the outset we said we would build a better bank, and that is what we are trying to do. It makes sense from both a customer and a business perspective. The result? Canada Trust customers are gaining access to a broader product range and to superior services like TD Waterhouse and a broader branch and ATM network. TD customers are getting longer branch service hours and a return to a clear customer focus.
Is it painless? No. But it is probably not as painful as people expected, and in the end, we will have a better bank for Canadians.
So I think in answer to the first question, we are able to tell Canadians, that we are listening even as we grow, and that, although it is early days in the TD Canada Trust merger, it is possible to have a merger that is done right.
Does TD have an aggressive strategy to go abroad? Let's look at TD Waterhouse. Here is a Canadian company that grew organically and by acquisition. It started out as TD Greenline, making a couple of local market acquisitions and growing until it had the skill set and the clout to be able to acquire Waterhouse. Let's be clear. TD was able to acquire Waterhouse because of its strength in Canada. The acquisition propelled it to become the world's second largest broker to self-directed investors, providing services to customers around the world and earning top brokerage status in its sector in the United States, the United Kingdom and Australia as well as at home in Canada. So TD Waterhouse used its strength to go abroad and build a Canadian-based champion.
Finally, it is clear that the fundamental question politicians, academics and consumers are asking is how to get the scale we need for international competitiveness while maintaining domestic competition. This is a legitimate issue and there are no easy answers, but we must find a way if Canada is to succeed economically.
As I see it, business leaders have an obligation to stop what Michael Porter calls the "slow drift down" in Canada's world standing. And the only way we can do that is by making our institutions as competitive as they can be. I have no doubt we have the capacity to be world class as long as we have the will.