Strategies for Banking Sector Modernization: Lessons from Canadian Experience

1. Strategies for Banking Sector Modernization:Lessons from Canadian Experience Financial Modernization Seminar Bank of Thailand January 22, 2002 Fred Gorbet Director, Financial Services Program Schulich School of Business (York University)

2. Agenda for this morning… • Background on Canadian financial system • Overview of MacKay Task Force • Some key implications of change and key issues outstanding • Lessons from the Canadian experience

3. Background: Constitution • Prudential Regulation: • Banks clearly federal • Credit unions clearly provincial • Everything else shared (but mainly federal) • Market conduct • Securities markets and licensing clearly provincial • But situation re: banks not clear (current legal challenge)

4. Evolution of Financial Sector • Clear importance of banks • Some world-class insurance companies, growing in importance • But no strong second-tier deposit-takers • Bank mergers a continuing, difficult issue for the industry and for the government

5. Relative size of major Canadian banks

6. Evolution of Financial Sector Nature of banks is changing • Capital markets are increasingly global • Banks supply less than 1/3 of corporate debt • Consumer risk/reward tradeoff shifting and banks becoming increasingly disintermediated (eg., mutual funds)

7. Changing role of banks: deposits and mutual funds…

8. Key regulatory developments… • No bank failures from 1923-1985 • Substantial change in late 1960’s • Deposit insurance introduced • Wide ownership of banks • Two bank failures in 1985 led to reexamination of system • OSFI created in 1986

9. Key regulatory developments… • “Four pillars” broke down in late 1980’s • Banks bought major investment dealers • Trust and loan industry essentially disappeared in 1990 recession • 1992 legislative reform effectively recognized convergence – 5 year sunset clause introduced

10. Recurring policy issues • Competition versus stability • Regional sensitivity • Community and small business access • National control and ownership • Rules versus discretion • Regulatory overlap and duplication

11. Task Force established in 1996… • First comprehensive look at sector since 1967 • Reported in September 1998 • More than 250 submissions; 100’s of meetings; • 18 research volumes; five background studies • 124 recommendations. • Virtually all recommendations accepted by government and became law in June, 2001.

12. Basic philosophy of Task Force • Change is pervasive – needs to be managed in public interest • Change driven by technology, globalization, changing consumer preferences, and demographics. • Change would continue to lead to new competitors, pressure on existing institutions, and convergence within the sector.

13. Banks are roadkill on the information highway Bill Gates, 1995 What we now describe as banks, trust companies, credit unions, insurance companies, mutual fund companies and securities dealers may well be unrecognizable within the coming decade. (MacKay Task Force Report)

14. Managing Change in the Public Interest Requires…. • A vision – should be consumer driven • Leadership and flexibility in achieving this vision

15. The vision of the Task Force • Robust competition and consumer choice • Successful financial institutions headquartered in Canada and competitive at home and abroad • Empowered consumers • Responsible financial institutions • Streamlined and effective regulation

16. Increasing competition • Ownership policy • Foreign entry • Access to payments system • Easier start-up conditions • Increased business powers (rejected) • Capital tax holiday for startups (rejected)

17. Institutional Adaptability • Clear and transparent merger process • Allow organizational flexibility through regulated holding companies • New definition of wide ownership to allow strategic investments • Expand range of permitted activities • Remove capital taxes on financial institutions

18. Empowering Consumers • Improved framework for competition through empowered consumers • Disclosure/Transparency • Privacy • No coercion (particularly tied-sales) • Easy and accessible redress through ombudsman

19. Responsible Financial Institutions • Access to basic banking services • Notice to close branches • Annual accountability statements • New framework to monitor and report on financing of small businesses

20. Streamlined and Effective Regulation • Competition vs. institutional safety • Make OSFI responsible for consumer protection for federal institutions (new agency instead) • Integrate consumer protection plans (rejected) • Government moved on own to give OSFI new powers and to strengthen Ministerial oversight of payments systems

21. Implications of change • Much more competitive retail marketplace • Intensification of convergence; banks will continue to become “less special” • Expect greater strategic diversification • Major bank mergers unlikely for some time; but holdco’s provide new options • Consolidation will continue

22. Challenges for regulators • Manage shift in balance (competition vs. safety); mindset and culture • New rules for holding companies • Are banks still special? How to deal with “too big to fail” issue? • Implications of North American integration

23. Key Issues Outstanding • Regulatory overlap and duplication still exist, particularly in securities markets • Implications of convergence for consumer protection plans still need to be addressed • Corporate governance; and interaction of regulators and boards • Continuing health of Canadian banks in an “over-banked” marketplace

24. Lessons from Canadian reform experience • Speed is important • A clear vision is essential • Build in flexibility of action • Emphasize transparency • Build an integrated regulatory structure • Staff it with the right people • Let them do their job and support them