Financial Services and Public Policy

Financial Services and Public Policy
Christopher Waddell (ed.), 2004 (Paper ISBN: 1-55339-068-7 $34.95) (Cloth ISBN: 1-55339-067-9 $75.00)

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Acknowledgements . . . iii
Welcome . . . ix
Message from the Organizers . . . xv
Chrisopher Waddell

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Three Perspectives on the Issues
Research in Financial Services and Public Policy: Filling the Gaps
David Dodge, Governor, Bank of Canada

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The 3 Cs for Improving Securities Law Enforcement: Coordination, Cooperation, and Communication
David A. Brown, Chairman, Ontario Securities Commission

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Remarks to the Financial Services and Public Policy Conference
Harold MacKay, Clifford Clark Visiting Economist, Finance Canada

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Access to Financial Services
Access to Financial Services for Tiny Businesses: What is the Role of Microcredit?
Toni Williams

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Market Gaps and the Financing of New Technology-Based Firms
Miwako Nitani, George H. Haines, Jr., Judith J. Madill, Barbara J. Orser and Allan L. Riding

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Law, Finance, and the Canadian Venture-Capital Cycle
Douglas J. Cumming and Jeffrey G. MacIntosh

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Local Competition and the Price of Banking Services
Mario Fortin and André Leclerc

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Strategic and Management Challenges for Financial Services
Voluntary Turnover: Knowledge Management -- Friend or Foe
Nick Bontis and Meaghan Stovel
. . . 217
Extended Abstract: The Impact of ATM Surcharges on Large versus Small Banks: Is There a Switching Effect?
Nadia Massoud, Anthony Saunders and Barry Scholnick
. . . 243
Banking Production Measurement, Rationalization and Efficiency of the Caisses Populaires Desjardins
André Leclerc and Mario Fortin
. . . 251
New Forms of Competition
The Distribution of Property/Casualty Insurance in Canada, Past, Present and Future
Mary Kelly and Anne Kleffner

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Foreign Bank Branching as a Means of Entry Into Retail Banking
John Chant

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Dissertation Research
Canadian Bank Mergers, Rescues and Failures
Marie-Hélene Noiseux

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Secrets, Lies and Economic Inefficiency
Tessa Hebb

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The Utilization of Heuristics by Novice and Habitual Business Angels
A. Ellen Farrell, Carole Howorth and Mike Wright
. . . 357
Financial Governance and Regulation
Financial System Analysis: Theory and Application
Edwin H. Neave and Lewis D. Johnson

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Managing Contractual Risk Through Organization: Strategic vs. Consensual Networks
Jean-Pierre Gueyié, Klaus P. Fischer and Martin Desrochers

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Private Pensions and Government Guarantees
Norma L. Nielson and David K.W. Chan
. . . 477
Globalization and the Changing Role of International Private Financial Services Institutions
Tony Porter
. . . 507
. . . 536

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When the Government of Canada releases revised guidelines in the fall of 2004 to govern prospective mergers within the financial services sector, it will have been almost six years since it rejected the plans of Canada's four major banks to consolidate to become two.

On December 14, 1998, federal Finance Minister Paul Martin turned down plans to merge the Royal Bank of Canada and the Bank of Montreal that had been announced in January of that year and the Toronto-Dominion Bank and Canadian Imperial Bank of Commerce announced in April.

The proposals from the banks generated an extensive investigation and recommendations from the federal Competition Bureau and also created an immediate political controversy. How would the government respond? What were the facts about reduced competition and costs and benefits to the banks, personal and business customers, and the entire Canadian economy from the proposed mergers. Everyone had an opinion. Few had facts.

It had been almost a decade since banks and bank policy took centre-stage in national politics. The last time had been the mid-1980s' failures of Alberta-based Canadian Commercial Bank and Northlands Bank. But throughout Canadian history, banks and politics have always been intertwined because the public has a more direct vested interest in banks and other financial institutions than any other sector of the economy, and individuals express their concern to their politicians.

Financial institutions hold the savings of individual Canadians in savings and chequing accounts, and through other financial instruments encourage them to invest for the present and future and save for retirement. They lend Canadians the money to buy homes and make other major purchases. They facilitate virtually all transactions in our economy, increasingly through the credit or debit cards they issue.

Since the decision in the late 1980s to break down the four pillars of the Canadian financial system that had prevented cross-ownership between banks, trust companies, insurance firms, and brokerage houses there has been a huge consolidation of the financial services sector. At the same time there has been growing pressure to open the doors to more foreign competition in Canada while many Canadian institutions have sought and taken advantage of opportunities to expand outside Canada's borders.

It is usually mergers, crises or what are perceived as usury practices or attempts to limit competition by financial institutions that generate political controversy. The controversies multiply as the sector grows and changes and financial services have been in almost continual change for more than a decade.

While the world of financial services evolves, one thing that has not changed is the degree to which the political controversies about financial services are debated in what amounts largely to an information vacuum.

The environment in which the controversies emerge, in which the political debates are held and policy decisions made and implemented has too often been shaped primarily by impressions and anecdotes, rather than facts that flow from comprehensive research. This was true during much of the period from the banks' announcement of their intention to merge early in 1998 to the finance minister's decision to cancel their plans at the end of that year.

The September 1998 release of its report by the Task Force on the Future of the Canadian Financial Services Sector chaired by Harold MacKay began to address the gaps in research and information. Accompanying its report were 18 research studies that considered everything from the changing landscape of the financial services sector in Canada to ownership restrictions, taxation policies, the impact of new technologies on financial institutions, corporate and consumer lending practices and the venture capital sector, property and casualty insurers, the changing demands on employees in the sector, and the impact of all these changes on consumers both in Canada and from an international perspective.

The National Research Program in Financial Services and Public Policy launched by the Schulich School of Business at York University five years ago is built on the research foundation established by the task force. The goals are to expand on the work done for the task force and also to branch out to provide research on new, emerging issues around which future policy debates will centre and decisions be required. The research program also seeks to identify the "next generation" of Canadian researchers in this field within the Canadian university community, and facilitate the development of effective networks of cooperation among these individuals.

This volume summarizes the results of the some of that research as presented at a conference held at the Schulich School of Business in Toronto on April 22–24, 2004 (Additional information about the research program and other projects underway and completed can be found at

The results reported in this volume include work by some of Canada's leading researchers in financial services, plus work in progress by doctoral candidates who have chosen the financial services sector as their area of specialization. The papers are presented in the order in which they were considered at the conference. The volume also includes some of the discussion that took place with delegates after each series of presentations.

However, the results of the research contained in this volume could just as easily have been clustered around some of the key themes that have always dominated debate about financial services: the efficiency of financial institutions and Canada's financial system, the search for capital and the credit decisions made by institutions, the pension system, banking and future issues, and directions for regulation.

Greater efficiency is a frequent argument for mergers and consolidations, not only in financial services. It is also a central element of corporate strategic planning as Canadian financial institutions are increasingly facing global competition. A critical element of efficiency is how financial institutions manage the people who work for them. Nick Bontis from Hamilton's McMaster University examines how much attention financial institutions pay to leveraging the human capital that exists within their knowledge-intensive workforce. He also assesses the degree to which they have codified the knowledge their employees possess and placed a value on that knowledge to ensure valuable employees are retained and to assess the real cost to their operations of losing such key personnel.

André Leclerc of the Université de Moncton (Edmundston) and Mario Fortin of the Université de Sherbrooke consider efficiency through the eyes of Les caisses populaires Desjardins. In one paper they examine how the geographic location of individual local caisses populaires affects how they set interest rates on both savings and loans, working from the theory that in small communities of Quebec, Desjardins may have the market power to raise the price of its financial services when there is no local competition. Their second contribution to the volume analyzes whether recent rationalization and consolidation within Les caisses populaires Desjardins have increased the efficiency of the organization.

Jean-Pierre Gueyié from the Université de Québec à Montréal and Klaus Fischer from Laval University in Quebec City have also examined Les caisses populaires Desjardins and the credit union system in Ontario. They assess whether strategic networks are a more efficient way to manage a system of linked financial institutions by comparing the performance of the Desjardins network in Quebec with the more independent operations of individual credit unions in Ontario.

Efficiencies in the sale of property and casualty insurance in Canada are calculated by Mary Kelly of Wilfrid Laurier University, Waterloo and Anne Kleffner of the University of Calgary. They compare the costs of selling insurance through independent agents or brokers, selling it directly through an insurance firm's own sales force and distributing products directly to consumers through commodity channels such as mail order, call centres, and the Internet.

The final aspect of efficiency considered by the conference involves the impact of automatic teller machine (ATM) surcharges. Nadia Massoud from the University of Alberta in Edmonton has examined the impact of surcharges in the United States. Her study explores whether increasing surcharges by larger banks on the use of their ATMs by non-customers can be used strategically to attract customers to the larger bank to avoid such surcharges.

Many of the most controversial issues relating to financial services revolve around who does and does not obtain credit and how capital is raised to finance growth of both established firms and start-up businesses.

Not surprisingly, with the late 1990s boom and then bust of the high technology sector and subsequent attempts to revive it, the financing of start-up businesses is of considerable interest. Ellen Farrell from St. Mary's University in Halifax reports on the results of research that explores how both novice and experienced angel investors assess information and make decisions about what start-up ventures to finance.

Another aspect of venture-capital financing — the labour-sponsored venture capital corporation (LSVCC) — is examined by Douglas Cumming from the University of Alberta and Jeffrey MacIntosh from the University of Toronto. Their research calculates whether LSVCCs have increased the overall amount of venture capital available, assesses the value of LSVCCs as investments for individuals and examines whether the corporations have succeeded as a tool of public policy designed to encourage the growth of venture capital.

At the other extreme is micro-credit — very small loans made to individuals who are usually considered not creditworthy, to start small businesses at the community level. Toni Williams and Iain Ramsay from Osgoode Hall Law School at York University, Toronto report the results of their study of the introduction of micro-credit into Canada and whether the experiment has succeeded.

Finally, Allan Riding, Judith Madill, George Haines Jr., Barbara Orser, and Miwako Nitani from Carleton University, Ottawa examine the degree to which knowedge-based small and medium-sized businesses face disproportionate difficulty in obtaining loans in the commercial lending market. Their study is based on data from a recent large-scale survey of the financing experiences of small and medium-sized businesses in Canada — data that was gathered as a result of a recommendation of the MacKay task force.

Banks are at the centre of many of these decisions to extend credit, and too many mistakes in financing ventures that ultimately fail can threaten the liquidity and survival of any financial institution. Marie-Hélène Noiseux from Concordia University, Montreal provides an historical perspective on Canadian bank mergers and failures in her research that analyzes the 29 bank mergers and failures in Canada between 1900 and 1931.

John Chant of Simon Fraser University in Vancouver brings the bank merger and competition debate up to date with his study of the banking market within the European Union. He assesses whether the "single banking market" in Europe could be adapted to Canada to allow full-service branches of foreign banks into the Canadian banking market. Such an opening up of the market to foreign competition in Canada might compensate for reduced competition for consumers at the retail branch level if some of Canada's major banks are allowed to merge.

The aging Canadian population is also focusing increasing attention on the country's pension system. Two increasingly important aspects of the private pension system in Canada receive attention in this research collection. Norma Nielson from the University of Calgary has assessed the impact of the presence of Ontario's Pension Benefit Guarantee Fund (PBGF) in the marketplace. The public agency will step in if a pension plan becomes insolvent. Her study examines pension plan formation and continuation, pension plan type and participation, funding or underfunding, and financial performance of plans operating with the protection of the PBGF compared to plans in provinces where no such public guarantees underwrite pension plans.

Tessa Hebb of Oxford University in England focuses on the activities of the California Public Employees Retirement System (CalPERS) to determine how pension plans are using their power as owners of corporations to force changes in corporate governance practices.

Finally, no research program in financial services would be complete without considering regulation of the sector. The need for some form of regulation is a constant that will always be there, but like the industry itself it must evolve to keep pace with new trends, products, processes, and institutions. Increasingly that is done through a combination of public sector and private sector organizations that share responsibility for the governance of global finance. As financial institutions move beyond national borders where domestic regulators have no authority, another means must be found to ensure sufficient regulation to maintain consumer confidence in the institutions. Tony Porter from McMaster University analyzes how globalization and technological developments have substantially altered and enhanced the role of the private sector in the global governance of finance.

Edwin Neave and Lewis Johnson from Queen's University study regulation of financial services in Canada from a different perspective. They propose a theory of financial system activity and then apply that theory to regulation of the securities market by assessing both "risk-based" and "rules-based" approaches to regulation.

The volume then highlights the view of three of the leading figures in the Canadian financial services sector. David Brown, chairman of the Ontario Securities Commission, provides a detailed explanation of how the commission plans to increase its enforcement activities both within the province and in concert with international securities regulators.

Harold MacKay, the Clifford Clark Visiting Economist at the Department of Finance in Ottawa and chair of the 1998 Task Force on the Future of the Canadian Financial Services Sector, offers a strong endorsement of the proposal to replace provincial securities commissions with a national securities regulator.

And David Dodge, Governor of the Bank of Canada, offers suggested directions for the next phase of research. He highlights issues that will take on increasing importance in the activities and regulation of financial services in the future. He believes strongly that more research is essential to guide future debate about the regulatory environment essential for the continued success of the country's financial services sector.

This publication is a compilation of studies that cut across the changing landscape of financial services, highlighting the conclusions and recommendations from detailed and specific research, not anecdotes and impressions about Canada's financial services sector. This collection provides new insights into old issues and focuses attention on new challenges for regulators, the industry, and the consumer.

The financial services industry is constantly changing, and shows no sign of slowing in 2004 or for the foreseeable future in the face of globalization of opportunities and financial markets, the constant search by the sector for new products and services, and changing consumer demands.

When he turned down the bank mergers in late 1998, the finance minister issued a news release saying that:

Looking forward, we believe our immediate priority must now be to focus on establishing an appropriate policy framework for the financial sector for the 21st century.

The government will not consider any merger among major banks until the new policy framework is in place.

But even then, new proposals will first have to demonstrate, in the lights of the circumstances of the day, that they do not unduly concentrate economic power, significantly reduce competition or restrict our flexibility to address prudential concerns.

This can only be accomplished through continued study and research of the operations and activities of all players in Canada's financial system. The conclusions reached by the researchers whose work appears in this volume are critical in assisting policymakers, regulators, and those working in the financial services industry to determine how best to meet the challenges that lie ahead.

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I would like to take this opportunity to thank sincerely all the authors for their contributions and their prompt attention to the usual inquiries that occur when turning conference papers into a publication. Their efforts guaranteed their research would appear in a timely fashion when the issues they have analyzed are still at the centre of debates about future directions for the financial services sector in Canada. As well let me add particular thanks to Sharon Sullivan from the John Deutsch Institute for her tremendous attention to detail in compiling the final versions of all the papers and then her skillful oversight of the production of this publication.

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