TABLE OF CONTENTS

REPORTS OF THE STANDING COMMITTEES

AND OTHER COMMITTEES

As Considered by

The Council of the City of Toronto

on November 25, 26 and 27, 1998

ECONOMIC DEVELOPMENT COMMITTEE

REPORT No. 5

1Bank Mergers - Impact on Toronto as a Financial Centreand Legislation Respecting Canadian Financial Institutions

City of Toronto

REPORT No. 5

OF THE ECONOMIC DEVELOPMENT COMMITTEE

(from its meeting on September 18, 1998,

submitted by Councillor Brian Ashton, Chair)

As Considered by

The Council of the City of Toronto

on November 25, 26 and 27, 1998

1

Bank Mergers - Impact on Toronto as a Financial Centre

and Legislation Respecting Canadian Financial Institutions

(City Council on November 25, 26 and 27, 1998, amended this Clause by striking out the recommendation of the Economic Development Committee and inserting in lieu thereof the following:

"It is recommended that the Commissioner of Economic Development, Culture and Tourism be requested to prepare a more definitive position for the City of Toronto respecting bank mergers, taking into account the most recent Hearings on this matter, and report thereon to the Economic Development Committee.")

(City Council on October 28, 29 and 30, 1998, deferred consideration of this Clause to the next regular meeting of City Council to be held on November 25, 1998.)

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(Clause No. 1 of Report No. 3 of the Economic Development Committee)

(City Council on October 1 and 2, 1998, deferred consideration of this Clause to the next regular meeting of City Council to be held on October 28, 1998.)

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(Clause No. 4 of Report No. 2 of the Economic Development Committee)

The Economic Development Committee recommends the adoption of the report (September15, 1998) from the Commissioner of Economic Development, Culture and Tourism subject to striking out Recommendation (3) therein and substituting in lieu thereof the following:

"3.it is recommended that the Managing Director of Economic Development prepare a brief highlighting the importance to Canada of Toronto as an internationally competitive financial centre, and requesting the Federal Minister of Finance to prepare short and long-term employment impact assessments for the proposed bank mergers on Toronto and Canada, and that the Mayor, or his designate, make a deputation based on this brief to the Commons and Senate Hearings on the report prepared by the Task Force on the Future of the Canadian Financial Services Sector."

The Economic Development Committee reports, for the information of Council, having:

(1)Received the report (September 17, 1998) from the Commissioner of Economic Development, Culture and Tourism regarding Legislation Respecting Canadian Financial Institutions;

(2)referred the following motion of Councillor Giansante to the Commissioner of Economic Development, Culture and Tourism for a report thereon directly to Council for its meeting on October 1, 1998:

"(7)that the report (September 15, 1998) from the Commissioner of Economic Development, Culture and Tourism be amended by adding thereto the following additional recommendation:

'that the Brief to the Federal Minister of Finance:

(a)outline the concerns of the City of Toronto and the safeguards required to remain a major financial centre; and

(b)request the Federal Government to:

(i)support our efforts and programs to improve our infrastructure;

(ii)insist the Banks explore and evaluate other options;

(iii)retain current barriers for foreign ownership of Canadian financial institutions; and

(iv)support stronger controls to regulate tied (linked) selling of services'"

(3)requested the Commissioner of Economic Development, Culture and Tourism to submit a report directly to Council for consideration at its October 1, 1998 meeting on appropriate conditions which Council could recommend to the Federal Minister of Finance based on the recommendations proposed by Mr. Banka, Toronto Small Business Support Organization and Rosario Marchese M.P.P., presented to the Economic Development Committee meeting on September 18, 1998:

Proposed by Rosario Marchese, M.P.P.

"(1)That a Financial Consumers Association be established which could utilize the expertise of various lawyers, solicitors and economists with funding provided from the banks via their statement distribution;

(2)that a mechanism be established (such as the Community Reinvestment Act) which could allow access to the banks credit information with a view to achieving accountability; and

(3)that membership on the Boards of Directors of Banks be opened up to include representation from sectors such as consumers; shareholders; financial consulting groups, etc. in order to make banks more accountable." and

(4)referred the following recommendation to the Chair for consultation with the Commissioner of Economic Development, Culture and Tourism as to its feasibility:

"That Recommendation (3) of the report (September 15, 1998) from the Commissioner of Economic Development, Culture and Tourism, as amended, be further amended to provide that the requested Brief to the Minister of Finance be first submitted to the Economic Development Committee for consideration and subsequent submission to City Council."

The Economic Development Committee submits the following report (September 15, 1998) from the Commissioner of Economic Development, Culture and Tourism:

Recommendations:

(1)It is recommended that City Council ask the Minister of Finance to consider the impact of the proposed bank mergers on Toronto's status as an internationally competitive financial centre when reviewing the mergers;

(2)it is recommended that the Managing Director of Economic Development monitor the public hearings on the proposed bank mergers scheduled by the federal government in October and November, and report to the Economic Development Committee as required.;

(3)it is recommended that the Managing Director of Economic Development prepare a brief, based on this report, to be forwarded to the Minister of Finance respecting the bank mergers, and that the Mayor, or his designate, make a deputation at the Commons and Senate hearings in Ottawa;

(4)it is recommended that the Economic Development Committee meet with representatives of small businesses and affected special interest groups to ensure their concerns are identified and responded to in any future regulatory regimes;

(5)it is recommended that Council establish an on-going forum with the financial services sector including all of the major banks in Toronto, to address the issues surrounding the structural and technological changes occurring domestically and nationally in the financial services industry. These forums will provide input to the City's Economic Development Strategy Plan; and

(6)it is recommended that the Economic Development Committee oversee a process for effectively evaluating and responding to changes resulting from the proposed bank mergers and other changes occurring in the financial services sector.

Purpose:

To report on the implications for Toronto of the proposed mergers between the Bank of Montreal and the Royal Bank of Canada and between the CIBC and the TD Bank.

Funding Sources, Financial Implications and Impact Statement:

None at this time.

Background:

On January 23, 1998, the Bank of Montreal and the Royal Bank of Canada announced their intention to merge both banking groups into a new bank. At its meeting on February 4, 5 and 6, City Council had before it a motion from Councillor Moscoe asking staff to report on the implications for Toronto of the proposed merger. This motion was referred to the Urban Environment and Development Committee.

At its meeting on March 23, 1998, the Urban Environment and Development Committee had before it two reports from staff on the proposed merger. (City Treasurer dated March 9, 1998, and Economic Development dated March 6, 1998). The Urban Environment and Development Committee received the two reports and referred the matter to the first meeting of the Economic Development Committee.

On April 17, 1998, the TD Bank and the CIBC also announced their intention to merge.

At the first meeting of the Economic Development Committee on July 17, 1998, the bank mergers issue was deferred to the September 18, 1998 meeting of the Economic Development Committee.

Subsequently, staff organized meetings with all five of the major banks in Toronto, for all members of City Council. This report has been written to integrate the results of that consultation process and to reflect the announcement of the second bank merger (CIBC/TD Bank).

Both of these mergers require regulatory approval by the Canadian Competition Bureau and the federal Minister of Finance, as well as the shareholders of the four banks. In addition the federal Task Force on the Future of the Canadian Financial Services Sector, chaired by Harold MacKay, which was established before the mergers were announced, is expected to report on September 15, 1998. It is expected that the federal government will hold public hearings on the proposed bank mergers during October and November, 1998.

The Canadian Competition Bureau will report in November, 1998, on whether a merger lessens or prevents competition substantially when it creates, enhances or preserves market power. Market power is the ability to profitably maintain prices, quality, service and/or product variety for a significant period of time at levels that are less favourable to consumers than would exist in competitive markets. While the Bureau is often focussed on post-merger prices, service levels are recognized as being particularly important when analysing bank mergers.

The Minister of Finance will make the final decision as to whether the mergers are to be permitted or not. The Bureau's views will be an important input to this final decision-making process. There are, however, issues that lie beyond the mandate of the Competition Bureau that will also form a critical part of the government's final decision on the current merger proposals. These include: the impact of the proposed mergers on jobs; the accessibility and affordability of quality services for Canadian consumers; the ability of the banks to compete internationally; their ability to help Canadian businesses expand at home and abroad; and the impact on neighbourhoods and communities, whether large or small, urban or rural.

Comments:

Overview:

The two bank mergers are being proposed by the management of the banks. Assuming that the management of the banks is acting in the best interests of their shareholders and that they know their business better than most others, one has to conclude that the mergers are likely in the best interests of the banks. Therefore, the main question is whether the merger is good for the banks because it will make the banks more competitive, or because it will allow the banks to reduce competition thereby raising prices/reducing service.

If the merger allows the banks to become more efficient and the market for their services is largely competitive, these efficiency gains will be translated into reduced prices/improved services for the banks' customers as well as increased market share for the newly merged banks.

On the other hand, if the mergers allow the banks to restrict competition sufficiently to exercise market power, the mergers would tend to reduce the level of service enjoyed by the banks' customers and to increase the prices of those services. Another version of this second hypothesis is that the mergers will allow the merged banks to become more efficient, and that they therefore will initially offer better services at lower costs, which will put their other competitors (smaller banks, trust companies and credit unions) out of business. Finally, after solidifying their duopoly, the two remaining banks will take advantage of their market power in the domestic market to raise prices and take advantage of retail and small business customers.

All of the five large banks in Canada operate in multiple markets, offering many products and services. In some of these markets, it seems likely that the bank mergers will significantly reduce competition, particularly if federal legislation continues to restrict access to these markets by foreign competitors. However, most of the banks' lines of business are in markets that are unlikely to become less competitive because of the bank mergers. For example, 40 percent of the banks' earnings are outside Canada¹. To the extent that the mergers allow Canadian banks to reduce their costs and therefore become stronger competitors abroad, the mergers are good for Canada and Toronto.

It appears that we must choose between two views of the future of Toronto as a financial centre. Either Toronto is the third largest financial centre competing in a North American market, or Toronto is the dominant Canadian financial centre protected by natural and institutional/regulatory barriers to entry.

The view of the future presented by the banks that have expressed a desire to merge is of competing in a North American market. They say that competition is here now, and they need to remain among the 10-15 largest banks in North America to compete. "The status quo is not an option for the Canadian financial services sector."²

The other view says that it is difficult for foreigners to penetrate a market and that an integrated North American market for financial services is many years away. The markets for many financial services products are already highly concentrated and the mergers will allow the two largest banks to dominate the Canadian market for financial services. Furthermore, through the ability to restrict credit, the two banks could end up dominating most of the Canadian economy. If this later position is true, then the mergers are not good for Canada or Toronto.

It is clear that the financial services industry is currently undergoing a period of change in Canada and throughout the world. These changes are being driven by three forces: globalization, changes in information and communications technology and the changing demands of financial services customers. As recently as four years ago 50 percent of banking transactions took place in branches, today just 12 percent of the CIBC's transactions in the Toronto region are in branches.

The technological changes evident in retail banking, such as Automated Teller Machines (ATM's), telephone banking and most recently Internet banking, have been matched by advances in back office technology in financial institutions. As a result it is now possible for a foreign bank or, for that matter a non-bank, to offer many financial services products directly to customers, without investing in a branch banking network. Most people do not shop for a residential mortgage on the Internet today; however, it is easy to believe that in five or ten years these new distribution channels will have attracted substantial market share.

It was in recognition of these changes in the financial services industry that the federal government appointed the Task Force on the Future of the Canadian Financial Services Sector, chaired by Harold MacKay, which is expected to report on September 15, 1998.

Impact on Toronto as a Financial Services Centre:

Toronto's financial services cluster, largely located in the downtown, is very important, both to the regional economy and the Canadian economy. A 1991 study by Alan Rugman and Joseph D'Cruz, based on Michael Porter's work in the United States, identified ten strategic clusters of economic activity in Canada. Three of these clusters are located in Ontario: Toronto's Financial Services Cluster, the Southwest Ontario Automotive Cluster and the Southern Ontario Advanced Manufacturing Cluster. These clusters "form the basis for the development of an internationally competitive economy."³ Therefore, their importance is much greater than their direct employment, which is substantial in its own right.

Clusters of economic activity are very important because, "Once it has achieved a critical mass, a successful cluster will be self-reinforcing. The presence of a successful industry attracts new players, promotes product innovation and competition and encourages new businesses to grow."⁴ Furthermore, financial services is largely a traded service, and countries and regions have to export something in order to earn the ability to purchase goods and services produced elsewhere - Hollywood movies, Caribbean vacations, French wine or Romaine lettuce in December. Forty percent of the CIBC's net earnings are from outside Canada and ninety percent of their employment (though perhaps not payroll) is in Canada. Many of the best jobs are here, including many higher order head office functions, the design of new banking products and the development of training programs. Local economic multipliers are also much higher for a head office than for a branch plant.

The Boston Consulting Group estimated that in 1996, 25 percent of the output of the financial services sector in the Toronto region was traded internationally, 30 percent was traded nationally and only 45 percent was a non-traded local service. Boston Consulting also notes that in the future even many of the services they identified as "non-traded" (retail banking, life insurance sales, etc.) could be internationally traded if delivered electronically.⁵

Financial services is also an important sector because it is a high productivity and high investment sector. In a recent study for the Canadian Bankers Association, Peter Dungan, of the Institute for Policy Analysis at U of T, notes that output per employee is between 20 percent (for banking) and 10 percent (for financial services) higher than the private-sector average in Canada.⁶ In the long-run, productivity determines the incomes and hence the standard of living of Canadians.

Canadian banks may not be as large as the New York "money centre" banks that concentrate on the wholesale market, or as large as some of the new super-regionals that have been formed over the last ten years in the United States and are located in places like Charlotte, North Carolina. However, they are accustomed to running a continental branch network that is more advanced than anywhere in the United States outside California and are widely viewed as more efficient than many of their U.S. rivals.

The financial services sector employs 94,000 people in the City of Toronto and is the second largest contributor to total output (GDP) after the manufacturing sector. Directly and indirectly, the financial services sector generated nearly $21 billion in GDP in 1995, and was responsible for the employment of more than 320,000 people in the Toronto area. The banks are estimated to generate between 60 and 70 percent of all financial services GDP in the GTA.⁷

Table 1: Financial Services Sector Employment

In The City Of Toronto (1997)

Total Employ. Suburban Downtown

Branches15,45912,017 3,442

Admin Offices 50,49810,51039,988

Investment18,668 2,48216,186

Financing 9,050 4,818 4,232

Total93,67529,82763,848

Source: City of Toronto Planning Department Employment Survey 1997, see Appendix for more detail.

Clearly, the impact of the bank mergers on Toronto's status as an internationally competitive financial services centre must be one of the key considerations for the Minister of Finance when he reviews the bank mergers.

In the early 1970's, two Canadian banks were in the top 20 in the world (measured by size of assets); by the early 1980's, only one Canadian bank was in the top 20; today, only one Canadian bank remains in the top 50. The Royal Bank is currently the 49th largest bank in the world. The proposed merger between the Bank of Montreal and the Royal Bank would lift the new bank to among the top 25 banks in the world and the top 10 in North America. However, it is unclear if this will make the new bank more efficient. The recent experience of the Japanese banks (some of the largest in the world) shows that size is not in itself sufficient to guarantee success.

It is true, however, that in many of the banks' lines of business size does offer a competitive advantage. For example, the borrowing/underwriting needs of the world's largest corporations can only be served by very large banks. Size also matters to use back-office systems efficiently. Since many of the costs of developing new computer systems are fixed, larger banks can spread these costs over a larger number of customers and achieve lower average costs. Recent technological changes have increased the potential for these economies of scale.⁸

Scotiabank, and others arguing against the mergers, have pointed out that even with the mergers Canadian banks will be small by international standards. The Royal/Bank of Montreal would be one quarter the size of the largest American banks. Similarly, the largest mono-line financial services firms in the U.S., which specialize in the low-cost, large-scale delivery of a single standardized product such as credit cards, mortgages or mutual funds, are in some cases larger than the entire Canadian market for this service.

The mergers will not make the Royal Bank/Bank of Montreal or the CIBC/TD into a global full service bank, like Citibank or Barclays, but the new banks would rank in the second tier in North America. For example, in the market for credit card services, Citibank has approximately 50 million cards outstanding, MBNA (a mono-line firm) has about 30 million, and the newly merged Canadian banks would have about 10 million each.

After the merger, the Bank of Montreal/Royal Bank would continue to focus firstly on the Canadian market, secondly on NAFTA, and third on selected products in selected overseas markets. CIBC/TD plans to expand quite aggressively into the American market, building on the TD's strength in discount brokerage and probably by acquiring a mid-size bank in the United States. Without the merger it is unlikely that either the CIBC or the TD could purchase a mid-size bank in the U.S.

In the short-run it is expected that the proposed bank mergers will have a negative impact on bank employment in Toronto; however, in the long-run it is expected that the efficiency gains that the merger will achieve will make Toronto banks more competitive and therefore will increase their international market share, which should lead to higher employment levels. Of course the greatest threat to Toronto as a financial centre would be if one or more of the banks were to be taken over by a larger bank from outside the country. For example, Los Angeles lost most of its banking jobs when the two major banks headquartered in Los Angeles were taken over by San Francisco based banks.

Closure of Bank Branches:

One of the expected outcomes of the proposed bank mergers is the closure of many bank branches across the country. In fact, a recent study published by the C.D. Howe Institute cites branch closures as the main source of efficiency gains from the mergers. These efficiency gains were estimated to be 20 percent of the non-interest expenses of the banks that are merged.⁹ Because of technological changes, such as the introduction of automatic teller machines and a population shift from rural parts of the country to the cities, Canada has more bank branches than is efficient. The closure of some of these branches would take place without the mergers; however, the mergers allow this process to be accelerated.

While the closure of bank branches presents many adjustment issues, it is also the source of much of the efficiency gains that are possible in retail banking now that 85 percent of banking transactions are automated. The issues raised for retail customers are similar to the adjustments that were experienced in food retailing in Toronto in the 1970's, as a relatively large number of small grocery stores, dating from the 1920's (5-6,000 sq ft) and from the immediate post-war period (15-20,000 sq ft) were replaced by a much smaller number of larger stores (30,000 sq ft).

A significant reduction in the number of bank branches in Toronto also presents some interesting challenges to the City in how these buildings can be recycled in ways that maximize employment opportunities and minimize the loss of property tax revenues. Concerns have been raised about the impacts on the rest of the retail strip when bank branches are closed. These issues need to be addressed. However, it must be recognized that the number of bank branches will continue to decline with or without mergers.

It is expected that the banks will continue the dialogue that they have started with the City over the last six months, and that they will work with local economic development offices to ensure that as many of the branches as possible are recycled for employment uses. Many of the bank branches are grand buildings, which are located on some of the most prominent corners of our retail strips; therefore, it would be a shame if a concerted effort were not made to preserve these buildings.

Many owner/operators of small businesses, particularly retail businesses, fear that the closure of bank branches will exacerbate a problem that they have been encountering with increased frequency when dealing with the banks. Local branches of banks are refusing business deposits, forcing the owner or employee to drive or walk, sometimes several kilometres, to their local business branch. The owners/operators of small retail businesses need to make cash deposits quickly, easily and safely. Night deposits are a particular issue for many retailers. If the bank mergers accelerate the trend to specialized business branches, many small retailers may be negatively impacted by the mergers. However, there is no evidence that the bank mergers will accelerate the trend to local branches that refuse business accounts.

Impact on Employment:

The most obvious consequence of closing a large number of bank branches is the potential impact on employment. The Bank of Montreal has closed six branches in Toronto and the Royal Bank has closed eight since the announcement of the merger in January. Both banks maintain there have been no layoffs; all employees were offered positions within the banks except for one who retired. Generally, the trend over the past few years has been towards fewer branches with increasing use of ATMs, phone banking, personal computer banking, and, more recently, home banking. While jobs at the branch level are also decreasing, it is important to note that employment overall in the financial services sector has risen.

The expected loss of branch jobs is not expected to result in an overall loss in employment by the financial services sector. While there may be fewer branch oriented positions, it is anticipated that positions in call centres and administrative centres will be increasing as will positions in the middle to upper range of investment and global banking. The Royal Bank and Bank of Montreal have committed to spending $750 million over five years in retraining and repositioning employees.

The Bank of Montreal/Royal Bank have predicted that the short-term impact of their merger could be an up to ten percent (9,000 jobs nationally) reduction in total employment at the Bank of Montreal and the Royal Bank. However, the banks predict that at the end of a five year period post-merger, employment at Royal/Montreal will actually have increased. For Toronto this could be good news overall, as a lot of the increase in centralized employment is likely to take place in Toronto. The 1995 merger of two major Toronto brokerage firms, Nesbitt Thomson and Burns Fry, creating Nesbitt Burns, saw predictions of a 25 percent decrease in the work force. Three years later there were 700 more employees with the company than before the merger, a 20 percent increase.

The American experience with bank mergers also indicates that total employment at the merged institutions increased on average within two to three years of the merger. However, it is difficult to draw conclusions about the proposed Canadian bank mergers from the American data, because many of the American mergers were of banks that had geographically complementary rather than substitutable assets.

Impact on Competition:

The largest worry about the impact of the bank mergers is a possible decrease in competition. While it is clearly beyond the scope of this report to determine the impact of the proposed mergers on competition, several observations are likely to be helpful. Firstly, most of the figures that have been reported on both sides of the debate are subtly misleading. Scotiabank has reported that Royal/Montreal will have a 39 percent market share of "core banking" personal deposits; they are excluding trust companies and many other institutions that offer similar services. The Bank of Montreal, on the other hand, reports that Royal/Montreal would have a combined 16 percent of the total domestic assets of financial institutions, which includes many dissimilar products (including pension funds).

A recent study, published by the C.D. Howe Institute, which concluded that the mergers provide benefits for Canadian consumers, added the following caveat "if and only if the government allows the rationalization of the branch network and domestic staffing and if it permits the entry of other firms, domestic and foreign, into the market for banking services".¹⁰ Clearly, there are lines of business and/or specific markets where the mergers will create situations where the banks could exercise market power to raise prices and take advantage of consumers and other bank customers.

Generally, there are two ways of dealing with the potential of these mergers to reduce competition in the market for financial services in Canada: regulation and new competitors. Both of these approaches present risks.

If we allow foreign competitors more access to the Canadian market, Canadian customers will benefit from lower prices and the product innovations that increased competition offers. However, there is a very real risk that we may lose many financial services jobs to other cities, outside Canada.

The regulatory route is even riskier. Highly regulated markets are not places where innovations are developed or even rapidly adopted, as it is not possible for regulators to adapt as quickly as firms to changes in this rapidly changing industry. For example, New York lost a great deal of business to London in the 1970's with the emergence of Euromarkets, which are U.S. dollar denominated bonds issued outside the United States in order to avoid U.S. regulations, that have subsequently been lifted.

The market for lending to small and medium size businesses (SME's) is of particular concern as this sector is one of the most important sources of new jobs in the Canadian economy and is much more reliant on the banks for debt finance than are large corporations, which increasingly are accessing capital markets directly. However, in this area Wells Fargo has recently pioneered a new program of business loans that are approved over the phone from a call centre in the U.S. Rather than incurring the substantial costs involved in setting up a subsidiary in Canada, Wells Fargo contacted a large number of potential clients (mostly small businesses) in Canada by direct mail, offering unsecured lines of credit between $15,000.00 and $75,000.00. The loans were processed over the phone by the bank's call centre in Colorado using a 1-800 number, and were approved within 48 hours of application.

The Wells Fargo example provides both comfort and concern to the Canadian policy maker: comfort that if the mergers are approved new competitors will emerge to serve Canadians, and concern that Wells Fargo has developed risk management systems that it allow it to offer its services in a fairly complicated market segment without making any investment in bricks and mortar (and jobs) in Canada.

A recent survey of their members by the Canadian Federation of Independent Businesses shows that 68 percent are opposed to the mergers, and 20 percent are in favour of the mergers. The numbers for Toronto show 66 percent opposed and 23 percent in favour. This does not mean that the mergers will be detrimental to small businesses; it only shows that small businesses perceive that the mergers will have a negative impact.

Scotiabank also cautions us that even in the absence of market power, the newly merged banks will be inwardly focussed for several years, as they try to make these amalgamations work; therefore, the newly merged banks are likely to become more conservative in their lending practices, which could lead to a credit crunch for small and medium size businesses in Canada. Banks have credit limits by market and sector; Scotiabank argues that these limits will be lower for a newly merged bank than they were for both existing banks combined.

Conditions on Approval of the Mergers:

The Minister of Finance does not only have a choice just between saying yes or no to the mergers, he could also approve the mergers subject to several conditions, such as no branch closures and no employment cuts. We would then get the reduction in competition caused by the mergers without benefiting from most of the potential efficiency gains, thereby limiting the long-term potential of these mergers to expand Toronto's role as an internationally competitive financial centre.

Other conditions that could be considered include those set out in the motion that is before your committee from Councillor Mihevc and Councillor Walker. The intent of the recommendations in this motion is certainly good - to improve access to banking services by small businesses and less affluent retail customers. The mechanisms to achieve these objectives may, however, create the need for another expensive bureaucracy and may create substantial compliance costs for the banks. Also, if Toronto City Council decides to ask the Minister of Finance to increase the amount of "red tape" with which the banks have to deal, this sends out a very negative image about Toronto as a financial centre. For these reasons, it is not recommended that City Council ask the Minister of Finance to impose numerous conditions on the proposed bank mergers. "Much of an international financial centre's success hinges on perception. Financial service centres must not only be open for business, but be seen to be open for business."¹¹

Conclusions:

It seems to be clear that, with or without the bank mergers, the financial services sector in Canada is currently undergoing a period of change. The changes in the financial services sector are largely being driven by technological changes; however, changes in customer preferences are also a major factor. The need for a branch network is no longer as paramount as it was even five years ago, and it is easy to foresee a world in which bank branches are only one way of delivering a wide range of financial services products. At the same time, the banking industry in the United States is also rapidly restructuring, as a wave of bank mergers there is creating ever larger institutions.

With all these changes in the market for financial services that are occurring around the world, it is important that we do not allow ourselves to become complacent about Toronto's position as a financial services centre. Toronto's financial services cluster is one of the ten strategic clusters of economic activity in Canada, on which the prosperity of all Canadians depends.

Permitting the four banks to merge into two, will create winners and losers. The shareholders in the merged banks are expected to be winners, otherwise the management of these banks would not be proposing the mergers. It is reasonable to assume that many (or even most) of Toronto residents are directly or indirectly (through mutual funds and pension plans) shareholders in these institutions. Other potential winners include new bank employees in expanding lines of business.

Whether the banks' customers are winners or losers depends on whether the mergers do more to increase efficiency or to reduce competition. On balance, it is expected that, particularly in a large market such as Toronto, there may be a modest positive impact from the mergers. At the same time, the mergers may have a negative impact on competition in some sectors, for example in the very important small business sector. Therefore, we are recommending that City staff track the impact of the mergers and work with the banks to explore ways of mitigating any negative impacts.

Clearly some people will lose because of the merger - for example employees that are made redundant and who do not want to be re-trained or are incapable of being re-trained. However, on balance, there will likely be more winners than losers because of the mergers. In the short-run, we expect that there will be some negative impact on bank employment in the City. Some analysts have predicted employment reductions as high as 5,000 in Toronto's Central Area. However, in the long-run, the mergers have the potential to be good for Toronto.

Contact Names:

Brenda Librecz 397-4700Peter Viducis392-1005

Ron Wandel 392-3384

Marion Brayiannis396-5056

¹Canadian Bankers Association, Canadian Bank Facts (1997/98), page 7.

²Bank of Montreal, Information on Merger Issues (1998), page 5.

³Alan Rugman and Joseph D'Cruz, Fast Forward: Improving Canada's International Competitiveness (1991), page 34.

⁴Boston Consulting Group, Financial Services at the Crossroads: The Current and Potential Role of Financial Services in the Greater Toronto Area (1997), page 19.

⁵Ibid, page 11.

⁶Peter Dungan, The Impact of Banking and Financial Services on the Canadian Macroeconomy (1997).

⁷Boston Consulting Group, Op. Sit. (1997).

⁸Frank Mathewson and Neil Quigley, Canadian Bank Mergers: Efficiency and Consumer Gain versus Market Power (1998), page 5.

⁹Ibid, page 19.

¹⁰Ibid, page 3.

¹¹Boston Consulting Group, Op. Cit. (1997), page 27.

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Appendix: The Financial Services Sector in Toronto: Background Report

Toronto has long been known as a major financial services and manufacturing centre in Canada. The financial service industry's significant place in the city is evident in its strong contribution to GDP and employment (figure's 1 and 2). Financial services represents the GTA's second largest contributor to GDP and its number five direct employer, placing the sector ahead of other major industries, including construction, transportation and communications. Over 70 percent of the financial services sector GDP contribution comes from the GTA, thus magnifying its importance to the local economy.

High Concentration in the Core:

Financial services are particularly important to the City of Toronto because of the industry's high concentration in the city centre. The sector is more heavily represented in the city than is any other industry in the province. Financial services is the second largest contributor to the City of Toronto's GDP and represents the third largest direct City employer. Also, over 60 percent of the sector's GDP contribution emanates from the City--over $10 billion.

Financial services were directly responsible for $12.2 billion in regional GDP in 1995 (9.5 percent of the GTA total). An additional $8.6 billion in GDP was injected into the GTA economy through the sector's spinoff benefits, which included purchases of professional services, telecommunications and computer specialists, etc.

The employment impact is equally significant: the finance sector directly employed 165,000 individuals (7.6 percent of total GTA employment). Secondary effects accounted for the additional employment of 158,000 people in the GTA. In the City of Toronto alone, over 93,500 people were employed directly in the financial services sector in 1997 (table 1). In total, the financial services sector generated nearly $21 billion in GDP and was responsible for the employment of more than 320,000 people, either directly or indirectly in the Toronto region.

The Banking Industry:

The main driver of financial services in the Toronto region is the banks, which generate between 60 and 70 percent of all financial services GDP in the GTA. In addition to providing channels for funds, banks also facilitate economic activity by directly financing governments, business investments and consumer purchases. At the end of 1996, Canadian chartered banks held almost $90 billion in personal loans, $200 billion in residential mortgages, $165 billion in business loans (including non-residential mortgages), and $130 billion in corporate and government securities, They are also substantial contributors to employment and the local tax base. As Table 1 revealed, nearly 66,000 persons were employed directly by banks and trust companies in the City of Toronto in 1997.

A major portion of employment in the financial sector is in the high value-added jobs upon which a strong economy depends. The sector typically provides employment with above-average salaries, a high degree of stability and strong qualification levels. In recent years, as growth has tended to concentrate in investment management and securities, the number of high-paying jobs has been increasing. There are nearly 50 percent more university graduates employed in the financial services industry than there are in the working population of the Toronto area overall. The same holds true for high school educated employees. Furthermore, financial services ranks third among the top GTA employers in terms of payroll per employee.

Many high-paying professional services rely upon the presence of a strong financial services sector for their business. Twenty percent of all lawyers and accountants are dependent on the financial sector, as are ten percent of all advertising professionals in Toronto. The creation of premium employment opportunities is a particularly important benefit as it helps maintain the vibrant downtown core associated with Toronto's financial centre.

The presence of a strong financial services sector is a major force driving the growth of the high tech industry in Toronto. Financial services account for 35,000 jobs directly in computer and telecommunications related functions in the region. Through its purchases, the industry also accounts for 9,000, or one in four computer service firm jobs, and almost 5,000, or one in seven telecommunications jobs in the Toronto region. It is also important to note the high degree of interdependence between financial and other services. Financial services are highly dependent on telecommunications and software services, sectors which, in turn, owe much of their growth to the success of financial services. The introduction of teller less banking and electronic trading, among other advancements in financial services, has prompted technological innovations in the telecommunications and computer industries.

The Structure of Banking and the Financial Services Sector:

One of the primary dichotomies of the financial services sector is between traded and derivative (or non-traded services). Traded goods and services are the main engine of economic growth. These are the goods and services that attract new wealth into the regional economy through exports by replacing imports (figure 3).

Non-traded goods and services, on the other hand, compete with firms within the economic region. While they are not primary wealth generators, the non-traded sectors are, nevertheless, an important base for traded services and help them maintain their competitiveness. Some businesses, including some financial services, have both traded and non-traded elements.

Financial services in the Toronto area are 55 percent traded and 45 percent non-traded (figure 4). Prime examples of non-traded services are sales offices for insurance and local bank branches. These offices compete with one another in providing services such as cashing cheques, withdrawing money and offering advice on financial matters. These are mainly local services that traditionally do not compete with others outside the region. In the future, however, some of these non-traded financial activities could be performed remotely through electronic means and become traded services.

A substantial portion of financial services in Toronto are nationally traded and could be located elsewhere in Canada. Some back office functions of banks and the headquarters of some domestic firms could, for instance, be located outside of Toronto and still operate just as effectively. About 30 percent of all financial services are traded nationally and could become internationally traded.

About 25 percent of the financial services activity in Toronto is internationally traded. Corporate finance and investment banking, for instance, are subject to intense international competition. In these areas, financial services in Toronto compete against the likes of New York, Chicago and even London. The clients for these services don't have to consult Toronto based banks to purchase the services they need; with modern telecommunications and air travel, they can buy similar services worldwide. Increasing global competition, deregulation and technical advancements are making it possible - indeed essential - for financial services firms to compete internationally in these areas. Over time, the proliferation of electronic banking and telephone and computer sales activities will mean that steadily growing portions of financial services will become nationally and eventually internationally traded.

The presence of large, successful, internationally competitive companies in Toronto clearly benefits the region. Canadian banks have been effective international competitors for a long time, and although they are growing their global operations, the vast majority of their employees continue to work in the region's downtown core. The international competitiveness of the financial sector thus preserves and creates valued employment in the city.

The Twin Engines of the Economy:

Toronto is one of few regions in North America with both a strong manufacturing and a strong financial services sector. The automotive industry, representing 17 percent of traded manufacturing, is the main driver of manufacturing in the region. Similarly, financial services, which accounts for 29percent of all traded services, leads the local services industry.

Although both financial services and automotive are economic growth leaders, there are several key differences in the activities and impacts of these sectors.

Unlike automotive industry suppliers, most of Ontario's financial services suppliers (almost two-thirds) are located within the GTA's borders and these tend to be densely concentrated in the downtown core. Financial service businesses are additionally important to the GTA economy because of the many businesses that are headquartered here.

As the financial services industry has grown, so has its importance and contribution to the Toronto and Ontario economies. An economic modelling study carried out by Peter Duggan of the Institute for Policy Studies at the University of Toronto demonstrated that additional growth of $1 million in revenue in financial services generated 33 percent more jobs in the Toronto area than an equivalent increase in automotive industry revenue.

Public Policy and the Banking Industry:

In 1900, changes to the Bank Act allowed banks to merge, thus anticipating the need for consolidation and economies of scale in banking and ultimately increasing the stability of financial institutions in Canada. It also allowed for national banking decades ahead of U.S. banks, which were limited to state banking activities.

In the 50s and 60s, the Bank of Canada removed interest rate caps. The fact that the U.S. did not remove caps destabilized its system and contributed ultimately to the savings and loans debacle of the 1980s.

In the late 80s, when capital markets were changing, Canadian banks were allowed to enter the securities business. Up to this point, Canadian investment banks tended to be small and undercapitalized on a worldwide scale. But mergers with chartered banks have allowed Canadian investment banks and securities firms today to compete on a more equal footing with large U.S. banks.

The Toronto Financial Services Cluster:

Toronto clearly dominates the Canadian scene for financial services. The Toronto financial services cluster is also strong in international terms.

Toronto is among the fastest growing financial centres in North America in terms of GDP growth and has the third highest concentration of financial services (figure 5).

Financial service firms have traditionally clustered in a few cities. These clusters have emerged as a result of numerous factors. London developed a strong financial services cluster as a world centre for trade in the 18th century. New York achieved financial services dominance by developing one of the first capital markets in the world in the 1860s and managing North American trade with Europe.

Currently, 75-percent of all Canadian banks and 70 percent of all Canadian insurance companies are headquartered in Toronto. Compared to other countries such as the U.S. and Germany, this is one of the highest levels of national clustering. Financial services cluster because the industry derives substantial value from co-location. Once it has achieved a critical mass, a successful cluster will be self-reinforcing. The presence of a successful industry attracts new players, promotes product innovation and competition and encourages new businesses to grow.

There are three types of financial services clusters (figure 6):

Global Clusters are international trading centres where many global firms are headquartered. New York, London and Tokyo are all global clusters, each located in a different time zone allowing for worldwide trading around the clock.

Secondary International Clusters are substantial clusters that serve regional markets in most businesses are perhaps global leaders in one or two segments. Chicago, for example, is a leader in commodities and derivatives trading. There are approximately twelve secondary international centres in the world today. Toronto, Hartford and Boston are secondary international centres that clearly depend on the strength of individual companies located in their midst. As a financial services centre, Toronto defines itself mainly through the presence of five large banks and the Toronto Stock Exchange's role as a regional stock market. Hartford is a major centre for insurance companies, while Boston is defined by its large mutual fund companies like Fidelity.

Local Clusters serve mainly local markets, have only limited national activity in large countries and are often the national centre in smaller countries. Local financial services clusters are found in Montreal, Vancouver, Los Angeles and Stockholm.

It is important to note that clusters at any level in the hierarchy are not static, having the ability to improve or worsen their positions with changes in circumstance and strategic positioning. Many financial clusters have moved up or down in the hierarchy as their situations have changed. Financial clusters depend on five underlying support mechanisms to provide the foundation for their growth and stability:

Structural Anchors - the presence of exchanges and a concentration of headquarters of financial services clients.

Accessibility and Quality of Infrastructure - telecommunications, roads and airports, high quality of life, excellent universities

Public Policy Environment - supportive regulatory environment, efficient regulatory bodies, policies that enhance competitive industry positions

Non-Financial Business Environment- strength of local economy, strength of national currency

Cost of Doing Business - taxes, wage rates, real estate costs

Some centres are beginning to move up the hierarchy by capitalizing on their unique strengths. Singapore, for example, has been able to secure a strong position through strategic marketing. On the other hand, financial centres like Frankfurt have declined because many of their growth foundations were weak and unnurtured. Los Angeles, once a secondary international centre, has been reduced to a local centre as San Francisco's financial services cluster continues to gain ground. Los Angeles has lost almost 45,000 jobs in financial services since 1990. Los Angeles suffered from the 1992 Bank of America takeover of Security Pacific, which resulted in headquarters functions and more than 10,000 jobs being eliminated or transferred to San Francisco. The financial services cluster in San Francisco has also been the beneficiary of the Wells Fargo acquisition of First Interstate (another Los Angeles company) in 1996, which brought more headquarters activity and employment to the area. Both of these cases demonstrate how the consolidation of headquarters was a key factor in determining the fortunes of financial services clusters.

Business Trends Affecting the Industry:

Several business trends are changing the face of the financial services industry in Toronto and in the industry worldwide:

CTechnology is increasing the mobility of industry functions. Satellite links and imaging technology, for example, are making distance irrelevant and allowing some business functions to move offshore. As telecommunication costs decrease, more functions can move anywhere and remain just as accessible and affordable.

CDecentralization of management authority is tending to weaken existing clusters. As businesses decentralize to be close to their customers and to where they do business, they may establish functions in places like Shanghai, Jakarta and Sao Paolo.

CNew competitors and the restructuring of distribution networks are also leading to job losses. In Toronto, the number of branch employees may decline as centralized call centres are established elsewhere. In the future, competitors who offer mortgages and loans over the Internet will increase competition for the local branches of banks.

Toronto will also face growing global competition in the mutual fund management area, which is becoming increasingly global. U.S. based firms are already tapping into this lucrative Canadian market. Toronto will also face increasing pressure to transfer functions out of the city region in order to compete with other attractive locations. While Toronto has not yet been adversely affected by global business trends, the region cannot afford to be complacent about the potential threat that these developments represent.

In some cases, these trends may become sources of new competitive advantage. For instance, unprecedented growth in personal advisory and money management services between 1990 and 1995 is now presenting some new opportunities for the financial.

Risks and Opportunities:

The increasingly traded nature of financial services in Toronto presents opportunities for growth and at the same time poses some competitive threats.

There are several factors prompting the increase in traded financial services activity (figure 7). Technological innovation and automation, in the form of automated teller machines and home banking, for instance, are replacing face-to-face activity for many customers. Communications costs are falling, allowing for increased remote processing and the placement of call centres in locations like New Brunswick. Furthermore, deregulation is opening the doors to new international competitors.

These trends are making an increasing number of financial services jobs mobile. Potentially up to 55 percent of all financial services jobs in Toronto could be performed elsewhere as new technologies are introduced in the future. These same technologies can enable Toronto to increase its employment through the export of newly mobile services. Maintaining and improving the foundations for financial services clusters can increase the likelihood of these functions remaining and growing in Toronto over the long run.

Technological Innovation:

New technologies ae making it easier to enter the U.S. market from Canada, just as U.S. competitors are gaining easier access to our market. Canadian banks, insurance companies and fund manager can capitalize on technological innovations to sell services to the U.S. via phone or electronic media without being physically present. The export of certain financial services does not require a local presence and can be handled via telecommunication. Money management and mutual funds are a case in point.

The Efficiency of Canadian Banks:

Canadian banks are widely viewed as more efficient than their U.S. counterparts (figure 8). Productivity ratios (expenses as a percentage of taxable revenues) of the top five banks in the U.S. and Canada show Canada's banks operating more efficiently. This is an area of expertise and success that our banks should be able to apply to other business activities, including the purchase and management of other interests, the use of new technologies, and the export of new services to international clients from their home base locations.

International Expansion:

Canadian banks and life insurers also have significant experience in international expansion as a means of leveraging their strength. Several Canadian banks are expanding into Latin America. Scotiabank has invested in Grupo Financiero Inverlat in Mexico, which will allow it to take a 55 percent interest by the year 2000. It is also building on existing affiliations with smaller banks in Chile and Argentina. Meanwhile, The Bank of Montreal has also bought a 16 percent share of Grupo Financiero Bancomer in Mexico.

There are an increasing number of Canadian banks buying U.S. institutions. The Bank of Montreal purchased Harris Bank and other Illinois based banks; The Toronto Dominion Bank bought the discount broker Waterhouse; and National Bank bought parts of New England Commercial Finance. Manulife and Sun Life have each expanded aggressively internationally, particularly in Asia.

Maintaining Back Office Jobs:

The loss of mobile back office jobs is a natural development of many large financial centres. The challenge for Toronto in this area is to develop employment in core areas of strength to stem the outward migration of jobs to other parts of Canada or to the U.S.

One of those core strengths is in educational infrastructure and skills concentration. Through its extensive network of post-secondary institutions, Greater Toronto offers advanced education and training programs that turn out highly qualified employees. The region's solid reputation for producing skilled knowledge workers in data processing and math may offer further opportunities for keeping and attracting specialized back office functions.

Strategic Niches:

Strategic niches can also be developed by building on national strengths in such areas as mining finance or in other resource sectors like forestry, oil and gas and utilities.

One financial services niche that exists in Toronto is mining financing. About 40 percent of all worldwide mining financing originates in Toronto. This strength can be traced back to the existence of a strong mining industry cluster in Canada and the fact that many senior executives and mining officials throughout the world were educated in Canada.

Sources:

The Boston Consulting Group (1997) Financial Services at the Crossroads: The Current and Potential Role of Financial Services in the Greater Toronto Area.

City of Toronto Planning Department (1997) Toronto Employment Survey. Various years.

De Reus, Mary ed. (1998) Toronto Business and Market Guide: A Profile of Toronto and the Greater Toronto Area. The Toronto Board of Trade.

Statistics Canada (1998) Employment Statistics for Metropolitan Toronto. Custom run--unpublished data

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Financial Services Sector Employment

In The City Of Toronto (1997)

Total Empl. Suburban Downtown % Downtown

Branches15,45912,017 3,44222.3%

Admin Off.50,49810,51039,98879.2%

Investment18,668 2,48216,18686.7%

Financing 9,050 4,818 4,23246.8%

Total93,67529,82763,848 100.00%

Table 1

Source: City of Toronto Planning Department Employment Survey 1997.

Employment Totals For Banks Requesting Merger

Table 2.

Source: Bank of Montreal, Royal Bank of Canada, CIBC and Toronto Dominion (1998).

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Figures 1 and 2

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Figure 3

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Figure 4

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Figure 5

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Figure 6

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Figure 7

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Figure 8

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Employment Surveys - Metro Total

1983 - 1997

The Economic Development Committee also submits the following report (September 17, 1998) from the Commissioner of Economic Development, Culture and Tourism:

Purpose:

To report on possible federal legislation that would help ensure that Canadian financial institutions remain accountable to consumer, small business and community interests.

Funding Sources, Financial Implications and Impact Statement:

None.

Recommendation:

It is recommended that this report be received for information.

Background:

At its meeting on June 3, 4 and 5, 1998, City Council had before it a motion from Councillor Mihevc and Councillor Walker asking Council to urge the federal government to enact legislation to ensure that Canadian financial institutions remain accountable to consumer, small business and community interests.

The motion was referred to the Strategic Policies and Priorities Committee, which received the motion and forwarded a copy to the federal government. At its meeting on July 8, 9 and 10, 1998, City Council referred the Clause of the report from Strategic Policies and Priorities Committee to the Economic Development Committee for consideration. City Council also requested the Commissioner of Economic Development, Culture and Tourism to report thereon to the Economic Development Committee at the same time as the report is brought forward regarding the proposed bank mergers. This report was prepared to respond to that request.

Comments:

Overview:

The motion tabled by Councillor Mihevc and Councillor Walker includes 14 separate recommendations directed at the federal government, which are designed to improve the level of service that financial institutions offer small businesses and consumers. All of these measures depend on regulation/moral-suasion to achieve the goal of encouraging the banks and other financial institutions to provide better service for their customers. An alternate approach, which could achieve the same results, would be to adopt measures that encourage competition in the market for financial services.

While one approach is not necessarily better than another in all cases, it is generally agreed that competition is preferable to regulation for several reasons. First, there can be significant compliance costs associated with regulatory regimes. Furthermore, requiring detailed reporting of operating decisions, may require firms to disclose information that would more properly be considered proprietary. It is also very difficult for regulators to adapt as quickly as firms are able, to changes in the environment; therefore, overly strict regulation is often a disincentive to developing new products and services or in adopting new practices developed elsewhere. Firms also waste resources lobbying for changes to regulations, and there is a risk that the regulations will not achieve the public policy goals they were designed to achieve or that they will compromise other, equally important, public policy goals. Finally, excessive financial sector regulation will create a negative image of Toronto as a financial centre. For all these reasons, over-regulation could make Toronto less competitive than other financial centres in the United States and overseas. Regulation should be seen as a second best solution, to be explored only if it is clear that competition is unable to achieve our public policy goals.

On the other hand, moral-suasion can be a very powerful force in society. People and firms act, not only in response to competitive pressures within a framework of laws and regulations, but also in response to subtle, and not so subtle, cues about what is right. For example, drunk driving is discouraged as much by our peers as it is by RIDE programs. Similarly, financial institutions are sensitive about their public image. When asked why service charges are lower in Canada than they are in the United States, a Canadian bank's representative's response had nothing to do with competitive pressures, but was that if the bank raised service charges it would be all over the front page of the newspapers the next day.

The first 52 recommendations in the report of the federal Task Force on the Future of the Canadian Financial Services Sector, released on September 15, 1998, are about enhancing and preserving competition in the financial services sector. It is clear that the Task Force is depending on competition as the primary means of ensuring that our financial services sector serves the needs of Canadians. However, the Task Force also notes that there is a legitimate basis in our history and our public policy framework for Canadians to have higher expectations with respect to banks than other private businesses. The Task Force's report includes several recommendations along the lines of those outlined below.

Specific Recommendations:

The recommendations in the motion before your committee include a variety of measures that can be grouped into six categories as follows:

(1)collect data about how well financial institutions are serving customers, with an emphasis on small business and retail customers;

(2)grade each institution's performance based on the data collected above;

(3)create incentives for financial institutions to achieve good grades under the performance grading system;

(4)establish an independent ombudsman for financial institutions;

(5)guarantee every resident of Canada a low-cost, no frills bank account; and

(6)require financial institutions to include flyers about a "Financial Consumer Organization" in their mailings to customers.

The first group of recommendations includes measures designed to collect data about how well our financial institutions are serving customers, with an emphasis on small business and retail customers. Most of this data would have to be collected by the financial institutions themselves. Data to be collected includes: number of loan applications, approvals and rejections by type, size and location; loan default rates, loan loses and number of loans called, by type, size and location; complaints received, complaints resolved; lawsuits by customers and their resolution; branch closures. In addition, the motion recommends an independent audit of whether the banks are providing basic banking services for all residents of Canada.

It is clear that reporting data about the number of branch closures would not be onerous, and in fact it would be reasonable to ask the banks to provide advance notice of branch closures, which would allow communities more time to adjust. It may also be reasonable to ask all financial institutions to provide more information about their lending activities to small businesses; however, it is also important to maintain the confidentiality of commercial relationships and not to create excessive reporting requirements. For example, it is not reasonable to ask financial institutions to report detailed data about every loan that was turned down.

The second measure, which is that the federal Superintendent of Financial Institutions grade each financial institution's performance based on the above data, may present some problems in determining the appropriate weighting for each variable. If all of these data are published, it would not be unreasonable for a number of agencies (public, private or non-profit) to determine their own weighting formulae and publish independent scorecards.

The third group of measures is designed to provide incentives for financial institutions to achieve good grades under the performance grading system described above, in addition to the subtle but important moral-suasion of publishing grades for each institution. Three measures have been suggested to put teeth into the performance grading system: a surtax on all financial institutions, combined with a tax credit based on the institution's performance; allocating government business only to those institutions that have good performance grades and denying expansion and merger applications by institutions with poor performance records. While the intent of these proposals is certainly good, Council should not endorse these recommendations for several reasons. First, different financial institutions may have, legitimately, chosen different niche marketing strategies. Second, these measures would appear to be much more interventionist than in other jurisdictions and, therefore, may make Toronto appear to be an undesirable place to locate traded financial services activities.

The fourth measure recommended in the motion is for financial institutions to fund an independent ombudsman. This measure, also recommended in the recent federal Task Force report, should be supported as it may provide more comfort to individuals and firms that feel that they have been treated unfairly than the existing Canadian Banking Ombudsman (CBO), which is industry sponsored, does not cover all financial services firms and is not be perceived as entirely independent.

The fifth measure, also supported by the federal Task Force, is to guarantee every resident of Canada access to a low-cost, no frills bank account. Access to a bank account at reasonable cost could be considered a necessity for most people in our society. The real question is who should subsidize this service. Food is a necessity; however, we do not ask supermarkets to subsidize food for low income Canadians. Similarly, if access to a basic bank account at reasonable cost requires subsidies, it would be more appropriate that these subsidies are from general tax revenue than from the providers/consumers of financial services.

The sixth measure is for financial institutions to include flyers about a "Financial Consumer Organization" in their mailings to customers. The task force also considered this proposal, but concluded that is was not comfortable making a recommendation in support of this measure. The groups supporting this measure were encouraged to further develop this proposal and once a broad consensus is reached to present a refined proposal to the Government.

Other Initiatives to Enhance Access to Capital by Small Businesses:

Staff of the Economic Development Division have been participating on a steering committee which is studying the access to capital issue in the GTA. The Toronto Access to Capital Committee (TACC) is composed of representatives from the Ministry of Economic Development Trade and Tourism, Industry Canada, Human Resources Development Canada (HDRC), private venture capital sector, Small and Medium Enterprise (SME) information providers, Credit Union Central of Ontario, and the major chartered banks. Facilitation has been made possible through seed funding provided by HRDC's Industrial Adjustment Service.

The original mandate of the Committee was threefold:

(a)to develop a "one-stop" shopping information and referral source for SME's to access information related to accessing capital to start or grow their business;

(b)to develop a communication strategy to increase the capacity of SME's to become investor ready; and

(c)to design a strategy that would develop the capacity of organizations acting as intermediaries to SME's to assist their clients in accessing appropriate forms of financial support.

This mandate has been developing since the Committee's inception in May, 1998. Recently, in response to an RFP, a consultant was approved to put together an inventory of SME information and help providers. Further RFP's are anticipated in the future to: 1) study/inventory capital providers; and 2) to develop a communications strategy. Additional research may be needed as the Committee's mandate grows.

Conclusions:

Supporting the development of small business is a key component of the City's economic development strategy, and access to capital continues to be a major concern for many small businesses. Therefore, the issues surrounding the financing of small businesses are a key component of the Economic Development Division's on-going workplan. The work of the Toronto Access to Capital Committee supports these objectives as do the recommendations in the motion before your committee today.

The report of the Task Force on the Future of the Canadian Financial Services Sector, released on September 15, 1998, also addressed many of the recommendations in the motion before your committee. Several of these recommendations should be supported and they could be included in the City's brief to the House of Commons and Senate hearings on the Task Force's report.

The recommendations to collect more data about each financial institution's record of small business lending is supportable, noting that it is necessary to maintain a balance between the desire for more data about lending to this very important sector and the confidentiality of commercial relationships as well as compliance costs.

It is expected that a variety of organizations (public, private and non-profit) will grade the institutions based on the published data and that the subtle but effective power of moral-suasion will help to achieve the important public policy objective of increasing the availability of capital to small and medium sized enterprises.

The proposal to create an independent ombudsman for financial institutions is also supportable and this measure should help reassure the banks' clients that they have not been treated arbitrarily.

Contact Names:

Brenda Librecz 397-4700

Peter Viducis392-1005

Ron Wandel 392-3384

Marion Brayiannis396-5056

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The Economic Development Committee reports, for the information of Council, also having had before it during consideration of the foregoing matter the following material:

-communication (March 30, 1998) from the City Clerk forwarding the action of the Urban Environment and Development Committee on March 23 and 24, 1998, wherein it directed that the matter of the impact on Toronto of the proposed merger of the Royal Bank of Canada and the Bank of Montreal be referred to the first meeting of the Economic Development Committee, once it is established;

-submission from the Bank of Montreal and Royal Bank;

-submission from the Canadian Federation of Independent Businesses;

-submission from Scotia Bank;

-submission from the Toronto Dominion Bank;

-submission from the Canadian Imperial Bank of Commerce;

-communication (August 12, 1998) from the City Clerk forwarding Clause No. 3 of Report No. 14 of the Strategic Polices and Priorities Committee, headed "Legislation Respecting Canadian Financial Institutions" and advising that City Council, at its meeting on July 29, 30 and 31, 1998 struck out and referred this Clause to the Economic Development Committee for consideration, with a request that the Commissioner of Economic Development, Culture and Tourism report thereon to the Economic Development Committee at the same time as the report is brought forward regarding the banking industry, which was previously requested by Councillor Moscoe.

The following persons appeared before the Economic Development Committee in connection with the foregoing matter:

-Mr. Maurice Hudon, Executive Vice-President, Ontario Division, Bank of Montreal and Mr. George Gaffney, Executive Vice-President and General Manager, Metro Toronto, Royal Bank;

-Ms. Judith Andrews and Mr. Ted Mallett, Canadian Federation of Independent Businesses;

-Mr. John Anderson, Vice Chair, Toronto Small Business Support Organization;

-Mr. John Banka, Toronto Small Business Support Organization;

-Mr. Warren Jestin, Senior Vice-President and Chief Economist, ScotiaBank;

-Mr. Bob Kelly, Vice-Chair, Retail Banking, Toronto-Dominion Bank and Mr. Mike Pedersen, Executive Vice-President, C.I.B.C. Branch Banking;

-Mr. Rosario Marchese, M.P.P., Trinity-Spadina; and

-Mr. Hugh Brown.

(City Council on October 28, 29 and 30, 1998, had before it, during consideration of the foregoing Clause, the following report (September 30, 1998) from the Commissioner of Economic Development, Culture and Tourism:

Purpose:

To provide a draft brief to the Minister of Finance as requested by the Economic Development Committee on September 18, 1998. This brief could be the basis of a presentation by the Mayor, or his designate, to the House of Commons and Senate hearings on financial services sector legislation.

The appended brief highlights the importance of Toronto's position as a major North American financial centre, and it also raises several other issues that are of particular concern to Toronto residents such as access to capital by small businesses.

Funding Sources, Financial Implications and Impact Statement:

None, at this time.

Recommendation:

It is recommended that City Council approve in principle the appended brief, and request the Mayor, or his designate, make a deputation to the Senate and Commons hearings on the report of the Task Force on the Future of the Canadian Financial Services Sector.

Council Reference/Background/History:

At its meeting on September 18, 1998, the Economic Development Committee had before it a report from the Commissioner of Economic Development, Culture and Tourism, which, as amended, recommends that staff prepare a brief to the Minister of Finance highlighting the importance to Canada of Toronto as an internationally competitive financial centre, and that the Mayor, or his designate, make a deputation based on this brief to the Senate and Commons hearings on legislation respecting Canadian financial institutions.

The Economic Development Committee also requested that the Commissioner of Economic Development, Culture and Tourism report directly to City Council on possible conditions that Council should request the Minister of Finance to place on the proposed bank mergers, and on the feasibility of submitting the brief to the Economic Development Committee for consideration before it is presented to the Federal Government.

Background:

The Federal Government established the Task Force on the Future of the Canadian Financial Services Sector, chaired by Harold MacKay, in December, 1996, to review financial services sector legislation. Subsequently, the Bank of Montreal and the Royal Bank of Canada announced their wish to merge (January 23, 1998). On April 17, 1998, the Toronto-Dominion (TD) Bank and the Canadian Imperial Bank of Commerce (CIBC )also announced their intention to merge.

The task force released its final report on September 15, 1998, which is the subject of Senate and House of Commons hearings. The House of Commons hearings in Toronto will be held during the week of October 14, 1998. The Senate hearings will be held in Toronto during the first week in November, 1998. It will not be possible to bring the brief back to the Economic Development Committee before the House of Commons hearings. However, the brief to the Senate Committee could be considered by the Economic Development Committee at its meeting on October 19, 1998.

In addition, the Canadian Competition Bureau is to report in November, on the impact of the proposed bank mergers on competition in the financial services sector. The Minister is expected to make the final decision, on whether the mergers are to be permitted, late in 1998 or early in 1999.

Conditions on the Bank Mergers:

Several of the deputants at the Economic Development Committee raised the possibility of asking the Minister of Finance to place conditions on the proposed bank mergers. A number of these initiatives were also addressed in the September 17, 1998 report to the Economic Development Committee.

The specific initiatives on which the Department was asked to comment include:

(1)Improved data collection about how well financial institutions are serving small businesses and other targeted groups;

(2)establishment of a Financial Consumers Association to be funded by the banks;

(3)widen membership of the Boards of Directors of the banks, to include representatives of consumers, shareholders and financial consulting groups;

(4)establish a mechanism similar to the Community Reinvestment Act; and

(5)measures to increase competition.

These initiatives could apply to all financial institutions, to all institutions that meet certain criteria, or only to large institutions that wish to merge with other large institutions. In the latter case, these initiatives would be conditions for the bank mergers.

It is difficult to imagine why these measures should be applied only to those institutions that wish to merge. The Federal Government has the authority to pass legislation requiring banks to comply with all of these measures as a condition of continuing to operate in Canada. The Federal Government does not need to negotiate with the banks. If these proposals are good public policy, they should be implemented whether or not the banks choose to merge. In addition, basic equity considerations imply that it is preferable to provide a level playing field for all competitors in an industry than to put different requirements on different organizations, though consideration could be given to exempting very small institutions from some of the proposed requirements.

The initiative to improve data collection by financial institutions was discussed at some length in the September 17, 1998 report to the Economic Development Committee. In addition, the MacKay Task Force report includes several recommendations dealing with these issues. Generally, these measures are supportable, subject to maintaining the confidentiality of commercial relationships.

The Task Force report also dealt with the proposal to require the banks to pay for a Financial Consumer Organization. The Task Force concluded that this proposal needs more work, and it encouraged the groups supporting this measure to further develop this proposal and to present a refined proposal to the Government.

The proposal to require that the banks broaden the representation on their boards of directors of certain sectors such as consumers, shareholders and financial consulting groups needs careful consideration. The board of directors of a public corporation primarily exists to represent the interests of the shareholders, though in many cases other stakeholders will also be represented. To require banks to modify the composition of their boards of directors, without consulting their shareholders, seems to usurp the authority of the shareholders.

The Community Reinvestment Act (CRA), which applies to banks in the United States, was designed to deal with a problem that was identified in the United States: that many banks deny loans to borrowers in poor inner city neighbourhoods. The MacKay Task Force notes that it has not been established that similar conditions exist in Canada, and that a full-blown CRA approach would be inadvisable in Canada at this time.

The specific community reinvestment proposal put forward by the Toronto Small Business Support Organization was that each of the banks that had expressed a desire to merge would be required to set aside at least ten percent of their assets for small business loans (less than $50,000.00). This proposal needs to be reviewed very carefully. The intent is to increase the availability of capital for small businesses, which is a goal that is shared by almost all policy makers in Canada. Small businesses are the most important job creators in Canada, and access to capital continues to be a major concern for many small businesses.

The main question is whether this measure is the best way to achieve the objective of increasing the availability of capital to small businesses. The Toronto Small Business Support Organization also recommended several measures to increase competition, which were similarly designed to improve the level of service provided to small businesses. It is preferable to rely on competition to achieve important public policy objectives, such as ensuring that small businesses have access to capital.

Competition is preferable to regulation for several reasons. First, it is very difficult for regulators to adapt as quickly as firms are able, to changes in the environment; therefore, overly strict regulation is often a disincentive to developing new products and services or in adopting new practices developed elsewhere. There can also be significant compliance costs associated with regulatory regimes. Furthermore, requiring detailed reporting of operating decisions, may require firms to disclose information that would more properly be considered proprietary. Firms also waste resources lobbying for changes to regulations, and there is a risk that the regulations will not achieve the public policy goals they were designed to achieve or that they will compromise other, equally important, public policy goals. Finally, excessive financial sector regulation will create a negative image of Toronto as a financial centre. For all these reasons, over-regulation could make Toronto less competitive than other financial centres in the United States and overseas. Regulation should be seen as a second best solution, to be explored only if it is clear that competition is unable to achieve our public policy goals.

In addition, the significant improvements in the reporting of small business loan activities endorsed by the MacKay Task Force, if implemented, will provide the public with improved information about the small business lending records of each financial institution, which will create public pressure on those institutions with poor records to improve their practices.

The measures proposed to increase competition include: reducing the barriers to the creation of new Schedule "A" banks, providing access to the Canadian payments system for a wider variety of financial institutions than at present, and eliminating the ownership restrictions on banks. Concomitantly, it may be necessary to tighten regulations regarding self-dealing. Measures to increase foreign competition should improve the financial services available to Canadians; however, they will also increase the risk of losing valuable financial services jobs to American centres.

The proposal to increase access by non-banks to the payments system is also a positive step; however, care must be taken to ensure that the integrity of the payments system is not endangered by allowing less creditworthy institutions to participate in the payments system. Like many of the other measures proposed by deputants at the Economic Development Committee, widening access to the payments system is a change that the Federal Government can make irrespective of the proposed bank mergers.

Brief to the House of Commons and Senate Hearings:

Appendix A, is a draft brief to the Minister of Finance as requested by the Economic Development Committee on September 18, 1998. This brief could be the basis of a presentation by the Mayor, or his designate, to the House of Commons and Senate hearings on financial services sector legislation.

The appended brief highlights the importance of Toronto's position as a major North American financial centre, and it also raises several other issues that are of particular concern to Toronto residents such as access to capital by small businesses. Rather than create a shopping list of every financial reform that would be desirable, it was decided that to achieve maximum impact, the brief should focus on the issue which affects Toronto disproportionately, which is the potential impact of the proposed changes on the financial sector in downtown Toronto.

This is not to say that the other issues surrounding the bank mergers are unimportant. The other issues are very important; however, most of these issues seem to be getting a lot of attention in the national debate over the bank mergers. What needs to be added to this debate is some consideration about Toronto's unique position. Toronto is the only place in Canada that has the potential to emerge, from the restructuring of the banking industry in North America currently underway, as a major North American financial centre.

There are two possible approaches to the goal of ensuring that Toronto remains a major financial centre. One approach is to ensure that Toronto based financial institutions are globally competitive. From a public policy perspective this does not mean do nothing; however, it is much less interventionist than the other approach, which is to try to achieve our public policy objectives by regulation. Unfortunately, it is not possible to put conditions on bank mergers that will ensure that Toronto based financial institutions will be successful in the North American marketplace. It may be possible, to the extent permitted under our foreign obligations (NAFTA and GATT), to limit entry to the Canadian financial services market and thereby try to ensure that Toronto remains the dominant financial centre in Canada.

There are, however, several risks associated with the protectionist/highly regulated approach. First, it may not be possible to exclude foreign competition. Second, other countries may retaliate. Third, Toronto's financial sector will become less innovative and will become slower to adopt innovations developed elsewhere. The MacKay Task Force points out that the world is moving toward a truly global capital market: "...money markets are almost fully global, bond markets are rapidly globalizing and the globalization of the world's equity markets has begun. ... Personal financial services are primarily domestic and, indeed, most retail and small business financial services are local. But even in these areas, movement is occurring that suggests the nature of the business will change over the coming decades." In the long-run, the protectionist approach would not be in the best interests of most of the consumers of banking services in Canada, and certainly would not be in the best interests of Canadian financial institutions.

The issues concerning the impact on competition of allowing the mergers to go forward are being addressed by the Competition Bureau in great detail and their report is expected in November, 1998. At that time, we will be in a better position to evaluate the impact of the mergers on competition and what conditions need to be placed on the banks to ensure that the mergers do not provide the banks with opportunities to exercise market power to the detriment of their Canadian customers.

There is also the alternative of insisting that the banks look at other options, such as joint ventures, in order to achieve the objectives such as efficient scale that the proposed mergers were designed to achieve. However, it should be noted that the banks are adamant that these kinds of arrangements do not work, and that it is likely that they have explored these alternatives in some detail.

Conclusions:

The appended brief highlights the importance of Toronto's position as a major North American financial centre, and it also raises several other issues that are of particular concern to Toronto residents such as access to capital by small businesses.

As instructed by the Economic Development Committee and to achieve maximum impact, the brief focuses on the issue which affects Toronto more than anywhere else in Canada, which is the potential impact of the proposed changes on the financial sector in downtown Toronto.

This is not to say that the other issues surrounding the bank mergers are unimportant. The other issues are very important; however, most of these issues seem to be getting a lot of attention in the national debate over the bank mergers. What needs to be added to this debate is some consideration about Toronto's unique position.

Contact Name:

Brenda Librecz, Economic Development397-4700;

Peter Viducis, Economic Development392-1005.

(Appendix A)

Draft Brief to Senate/House of Commons Hearings on Financial Services

I have come here today to speak to you about the recommendations in the report of the Task Force on the Future of the Financial Services Sector, and to convince you that Toronto matters.

Like people all over Canada, the residents of Toronto are concerned about the bank mergers. However, the level of anxiety is even higher in Toronto, because the decisions you make could have ramifications for Toronto that are larger than anywhere else.

As you consider the needs of all Canadians, I would also like you to consider the impact of your decisions on Toronto as an internationally competitive financial services centre. This is not merely a parochial concern. The financial services cluster, largely located in downtown Toronto, is very important, both to our regional economy and to the Canadian economy.

The first 52 recommendations in the Task Force's report deal with enhancing competition and competitiveness. I agree that competition is the paramount concern, and I want you to consider for a few moments the competitive position of the Toronto city region in North America.

Today, Toronto is the dominant financial services centre in Canada. Tomorrow, Toronto will have to compete directly with long-established financial centres in the United States, such as New York and Chicago, as well as emerging financial centres such as Charlotte, North Carolina.

I am not convinced that the proposed bank mergers will make Canadian banks better able to compete with their rivals south of the border. I do know that it is critically important to Toronto and Canada that they are successful.

The financial services sector is important to Canadians in two ways:

First, as customers we all benefit from an efficient and innovative financial sector - whether it is to pay our bills, save for retirement, or borrow to buy a house or start a business.

Second, this sector is an industry. Firms in this industry create jobs, pay taxes and contribute to our balance of payments. Firms in this industry, like in any other, must compete successfully in order to survive.

Firms in the financial services sector, as in most other industries, are not randomly scattered across the landscape. They are clustered in one place, which happens to be at the centre of the City that I represent and that I love.

By clustering in one place, financial services firms benefit from the synergies that develop between firms, customers and their suppliers. Clustering contributes in a major way to the success of these firms.

Ten strategic clusters of economic activity have been identified in Canada. Three of these clusters are located in Ontario: Toronto's Financial Services Cluster, the Southwest Ontario Automotive Cluster and the Southern Ontario Advanced Manufacturing Cluster.

These clusters are large employers in their own right; however, their importance is much greater than their substantial direct employment. Clusters of economic activity are very important, because they form the basis for the development of an internationally competitive economy.

Once it has achieved a critical mass, a successful cluster will be self-reinforcing. The presence of a successful industry attracts new players, promotes product innovation and competition, and encourages new businesses to grow.

Financial services is largely a traded service, and countries and regions have to export something in order to earn the ability to purchase goods and services produced elsewhere.

Forty percent of the CIBC's net earnings are from outside Canada and ninety percent of their employment is in Canada. The numbers for the other banks are similar.

Many of the best jobs are here, including many higher order head office functions, the design of new banking products and the development of training programs.

Local economic multipliers are also much higher for a head office than for a branch plant.

The Boston Consulting Group estimated that in 1996, 25 percent of the output of the financial services sector in the Toronto region was traded internationally, 30 percent was traded nationally and only 45 percent was a non-traded local service. Boston Consulting also notes that in the future even many of the services they identified as "non-traded" (such as retail banking and life insurance sales) could be internationally traded if delivered electronically.

The Task Force expressed it as follows, "We believe it is inevitable that direct access, increasingly through electronic channels, will take a far greater share of the market and that this will happen sooner rather than later." This means that Toronto will go from being the largest financial centre in Canada to the third, fourth or fifth(?) largest in North America.

Financial services is also an important sector because it is a high productivity and high investment sector. Peter Dungan, of the Institute for Policy Analysis at the University of Toronto, notes in a recent study that output per employee is between 20 percent and 10percent higher than the private-sector average in Canada. This matters!

In the long-run, productivity determines the incomes and hence the standard of living of Canadians. Or to quote a recent Industry Canada publication, "Total Factor Productivity is the broadest measure of the economy's efficiency in turning labour, capital, raw materials and ideas into goods and services. Our real wages and standard of living are largely determined by how fast our Total Factor Productivity grows."

Canadian banks may not be as large as the New York "money centre" banks that concentrate on the wholesale market, or as large as some of the new super-regionals that have been formed over the last ten years in the United States and are located in places like Charlotte, North Carolina. However, they are accustomed to running a continental branch network that is more advanced than anywhere in the United States outside California, and they are widely viewed as more efficient than many of their U.S. rivals.

The financial services sector employs 94,000 people in the City of Toronto and is the second largest contributor to total output (GDP) after the manufacturing sector. Directly and indirectly, the financial services sector generated nearly $21 billion in GDP in 1995, and was responsible for the employment of more than 320,000 people in the Toronto area. The banks are estimated to generate between 60 and 70 percent of all financial services GDP in the GTA.

Like Canadians everywhere, my constituents are worried about the proposed bank mergers. In the short-run it means branch closures and reduced employment levels. In the long-run we hope that the efficiency gains that the mergers will achieve will make Toronto banks more competitive and therefore will increase their international market share. If the banks are successful in completing in the North American market place, these mergers could lead to employment gains in the long run.

Of course, the greatest threat to Toronto as a financial centre would be if one or more of the banks were to be taken over by a larger bank from outside the country. Los Angeles lost most of its banking jobs when the two major banks headquartered in Los Angeles were taken over by San Francisco based banks.

It would be wonderful if we could wave a magic regulatory wand to ensure that Toronto based firms will be successful in the emerging North American financial services market. We cannot. However, there is an important role for regulation to ensure that all of our communities are well served by our financial services providers.

The financial district at the heart of Toronto is critically important; however, it would not be the great success that it has become if it were not surrounded by an exciting and vibrant city. Small businesses, like those that line many of our retail strips ensure that Toronto continues to offer a quality of life that is unmatched on this continent.

Small business is the largest job creator in our economy, and many owners of small businesses tell me that access to capital is their number one issue. We have to address this issue. The proposal in the MacKay report, to improve the data published about small business lending, is an important first step. Measures to encourage more competition may be necessary if the mergers are approved. Stricter controls to regulate tied selling may be necessary. The proposed bank ombudsman could also have an important role in ensuring that all Canadians are treated equitably by the major financial institutions.

Clearly, the impact of the bank mergers on Toronto's status as an internationally competitive financial services centre must be one of the key considerations for the Minister of Finance when he reviews the bank mergers. I trust that the Minister will keep Toronto's unique place in this issue in mind during his review and decision making process.)

(City Council also had before it, during consideration of the foregoing Clause, a Research Bulletin from the Canadian Federation of Independent Business, entitled "Toronto Small Business Views on Bank Mergers.")

(Councillor Pitfield, at the meeting of City Council on October 28, 29 and 30, 1998, declared her interest in the foregoing Clause, in that her husband is currently employed by a major bank.)

(City Council on November 25, 26 and 27, 1998, had before it, during consideration of the foregoing Clause, a Research Bulletin (undated) entitled "Toronto Small Business Views on Bank Mergers", submitted by Councillor Chow.)

(Councillor Pitfield, at the meeting of City Council on November 25, 26, and 27, 1998, declared her interest in the foregoing Clause, in that her husband is employed by a major bank.)

Respectfully submitted,

BRIAN ASHTON,

Chair

Toronto, September 18, 1998

(Report No. 5 of The Economic Development Committee, including additions thereto, was adopted, as amended, by the City Council on November 25, 26 and 27, 1998.)