Banks need to make their case

By Gérard Bérubé

Given the tabling of revised banking regulations in June and a promise that the proposals will be analyzed by September, the regulatory context would appear to be favourable to the banking sector. Hungry for mergers, banks and insurance companies still have to make a case for their proposals proposals to politicians with little inclination to open a front on a strategic issue for Canadians. With political priorities elsewhere, it's back to square one, especially after the failed merger attempts of 1998.

Then finance minister Paul Martin vetoed merger plans of Royal Bank and Bank of Montreal, CIBC and TD banks. In the fall of 2002, then prime minister Jean Chrétien blocked the merger of Scotiabank and Bank of Montreal. In the meantime, insurers moved to demutualize and consolidate, causing a rapid reorganization of the industry under three major players — SunLife, ManuLife and Great-West, whose size let them compete with the banks.

The Canadian financial services sector became centred around two pillars: the five big banks and three large insurance firms. Does the sector need to expand? Should consolidation be further encouraged and should inter-pillar mergers such as the abortive attempt by ManuLife and the CIBC be allowed? That's where we stand today.

Since our changing demographics favour insurance financial products and the more mature traditional market is reducing the banks' performance potential, banks are looking to mergers or acquisitions to expand. But enthusiasm is lacking in poli-tical circles and Martin is still reticent. "New proposals will first have to demonstrate ... that they do not unduly concentrate economic power or significantly reduce competition. And above all, they would have to be in the best interest of Canadians," he stated in 1998. There still isn't much political interest in this issue today.

     Banks have since shifted their expansion plans to the US. However, the process is much slower than hoped. Growth is impeded by several high-level US securities authorities. This increases transaction costs without any hope of offsetting them by higher yields or synergy gains, which are more limited in mergers between US and Canadian banks. What's more, Bank of America's offer for FleetBoston financial for US$47 billion bumped up the price list. Consideration must be given to the pressure on prices caused by US consolidations, where the number of banks has fallen to 8,000 today from 12,000 in 1991 (with projections of 5,000 in 10 years). And only a few, if any, synergy gains are possible.

Banks will have a lot of convincing to do, especially if they insist on promoting mergers among equals. They'll have to reassure consumers and small business owners who worry mergers will result in lost jobs, regional branch closings, fewer products and services and limited access. They will have to demonstrate that their proposal is more in the interest of the public than the shareholder and that there won't be any undue local concentration on the investment, mortgage, credit card and securities brokering markets. They will also have to contend with reports indicating mergers between large banks do not provide economies of scale or commercial advantages. An oft-quoted report by Finance Canada, the US Fed and Bank of Italy points out that mergers run counter to the objectives respecting econ-omies of scale, the integration of technological systems, improved management and the penetration of banking products into new markets.

And let us not forget that many US mergers destroyed value. If our banks go ahead with their proposals, the results will be especially spectacular — record profits reflecting a re- vival owing, paradoxically, to their refocusing on traditional activities or to leaving the loan sector to large US enterprises. In 2003, aggregate bank profits rose by $10 billion, or 21%. Brokerage firms forecast these results to grow 15% this year and 10% in 2005. With such figures, banks have accumulated a capital surplus of $24 billion and posted an average return on equity of 16%, nearly doubling the 2001 figure.

Even with support from the Senate's committee on banking, trade and commerce and a House of Commons committee, a major sales pitch is being made to show the relevance of bank mergers. Leo Kolber, chair of the Senate committee and former director of the TD Bank, says banks might be better off promoting mergers between banks and insurance companies — a much less threatening scenario. It remains to be seen if this type of concentration is what Canadians want.

Gérard Bérubé is editor of the Économie et finance section of Le Devoir in Montreal