CAN CONSUM ERS BANK ON M ERGERS? Robert R. Kerton Canada's large banks are again enchanted by a siren song of mergers that could see the good ship of Canadian banking founder on the rocks, suggests economist Robert Kerton, dean of arts at University of Waterloo and an authority on banking and consumer issues. The big banks may have already captured many of the economies of scale they would purportedly gain from mergers, but would do well to improve their service if they really aspire to be world-competitive. He enumerates five issues, including concentration of power, which proposed mergers should have to deal with, in the public interest—reason enough to retain parliamentary oversight. Les grandes banques canadiennes sont ravies de voir la question des fusions refaire surface même si, à l'instar des marins charmés par le chant des sirènes, cela risque de faire couler leur navire. Or, il est bien possible que les banques aient d'ores et déjà avoir réalisé la plupart des économies d'échelle qu'elles attendaient des fusions, mais elles tardent toutefois à améliorer les services à la clientèle. Elles devraient y songer sérieusement, si elles désirent vraiment être compétitives à l'échelle mondiale. Dans l'intérêt public, les fusions devraient être soumises à cinq conditions - notamment le niveau de concentration du pouvoir - et cela exige que le Parlement continue d'exercer son rôle de supervision. R elen t less is t h e siren so n g fo r m ergers am o n g Can ad a’s big ban ks. Siren s, o f co u rse, were sea n ym p h s wh o san g so en ch an t in gly t h at sh ip s wo u ld crash o n t h e ro cks. In a ban kin g co n t ext , su ch m u sic can be exp ect ed fro m t h o se wh o earn h u ge fees p u t t in g m ergers t o get h er, an d fro m rep airin g t h em lat er. Q u est io n : Is t h e fait h in et ern al eco n o m ies o f scale ju st ified ? Is it a siren so n g o f in n o cen t self-d elu sio n ,—a belief t h at h elp s o verco m e t h e d isco m fo rt arisin g fro m wan t in g a m erger fo r n o rm al reaso n s? It is im p o rt an t t o lo o k at im p art ial evid en ce o n t h e scale issu e, bu t first co n sid er t h e d egree o f scru t in y t h at is given t o m erger p ro p o sals fro m Can ad a’s largest ban ks. A m erger am on g big ban ks faces th ree tests: for p ru d en tial safety, for com p etition , an d for th e p u blic in terest. Th at seem s like a lot. Is it? Do we n eed fu rth er p rotection t h ro u gh a p o lit ically d riven p u blic in t erest t est ? Last October, th e m in ister of fin an ce asked both th e Stan d in g Sen ate Com m ittee on Ban kin g an d Fin an ce an d th e Hou se of Com m on s Com m ittee on Fin an ce to assess th e m atter. By Decem ber, th e rep ort of th e Sen ate com m ittee was ou t, an d it d elivered a m essage th at is very clear in recom m en d in g th e rem oval of Can ad a’s p u blic in terest test for p rop osed m ergers am on g large ban ks. It recom m en d ed , “p arliam en tary com m ittee review of sp ecific ban k m erger p rop osals n o lon ger be req u ired ….” 16 OPTIONS POLITIQUES M ARS 2003 Evid en ce on m ergers in gen eral is a cau tion to th e son g of th e Siren s. Most m ergers d o n ot p ass th e m arket test. In an assessm en t of abou t 300 big m ergers, a recen t Business W eek an alysis sh ows th at 61 p ercen t of bu yers d estroyed sh areh old er wealth . Big ban k m ergers d id n ot ach ieve th e $100 billion d estru ctive cap acity of th e AOL Tim e Warn er m erger, bu t Fleet Boston , Ban k On e, Nation sban k an d th e oth ers d estroyed 10 p ercen t of th eir valu e becau se, as Business W eek p u t it, th ey “en vision ed gran d syn ergies th at p roved illu sory or u n workable.” Th e collap se of th e m erger m ovem en t, an d th e h u ge p ortion of m arket valu e d estroyed by th ose m ergers, sh ou ld h ave cau sed every an alyst to look m u ch m ore carefu lly at assertion s th at m ergers am on g gian ts will im p rove th e p rosp erity an d com p etitiven ess of th e n ation al econ om y. Th e com p etitive race m ay go to th e swift—to th e agile—n ot to th e on e with th e m ost bu lk. W h en we m erge two gian ts, we p aste togeth er two d ifferen t n etworks of in form ation ; we o ft en ad d t wo co rp o rat e cu lt u res. Th is can resu lt in Tyran n osau ru s rex. T h ere is a lot to be said for ban ks of th e cu rren t size in Can ad a, or for a few m ore p articip an ts. In d eed , th e Sen ate rep ort n oted th at barriers to en try n eed atten tion . Big ban ks n ow offer im p ressive tech n ological services an d th ey are am on g th e best of corp orate citizen s in d on atin g to Can consumers bank on mergers? co m m u n it ies an d in vest in g in t h e fu tu re of Can ad a. Do ban ks h ave th e com p etitive agility to com p ete abroad ? Evid en ce from p reviou s attem p ts is n ot reassu rin g: Un wise loan s to th e Can ary W h arf p roject in th e UK m ean t th at two of ou r largest ban ks wrote off losses of abou t $800 m illion p er year for five years. In t h e last few years, m an y ban kers h ave been m ore d irect, an d m ore cred ible, in statin g th at th e issu e is sim p ly th e growth of th e ban k, wh ich can be ach ieved m ost q u ickly th rou gh m ergers. Th e n ation al in terest is n ot th e m ain job of ban kers. Th e q u estion is: Wou ld m ergers am on g big ban ks m ake th in gs better, or worse, for u s all? Hist o rically, Can ad ian sen at o rs an d Can ad ian ban ks h ave always been close to each oth er—th e Sen ate really u n d erstan d s ban ks—an d recen t h earin gs attest to th at. Bu t, if th e good Sen ators h ave a carefu l u n d erstan d in g of wh at is good for ban ks, it d oes n ot n ecessarily follow th at th eir ad vice is always bad for th e rest of u s. Th eir m ain con clu sion was word ed in several ways. Th e m ost in terestin g p h rasin g was, “We con clu d ed th at, on ce th e p ru d en tial an d com p etition con cern s were ad d ressed , a m erger wou ld be a n et p ositive for Can ad ian s.” It raises t h e issu e o f wh et h er t wo o t h er t est s are en o u gh t o lo o k aft er t h e p u blic in t erest . Th e O ffice o f t h e Su p erin t en d en t o f Fin an cial In st it u t io n s (O SFI) ap p raises p ru d en t ial m at t ers. Th e Co m p et it io n Bu reau ap p raises m arket issu es. Fact o rs t o be co n sid ered by t h e Bu reau an d t h e Tribu n al an d exp ressly referred t o in t h e Act in clu d e: t h e am o u n t o f fo reign co m p et it io n ; wh et h er a p art y t o t h e m erger h as failed o r is likely t o fail; availabilit y o f su bst it u t e p ro d u ct s; an y b arriers p reven t in g n ew co m p et it io n fro m en t erin g t h e m arket ; t h e ext en t t o wh ich effect ive co m p et it io n rem ain s in t h e m arket ; t h e likelih o o d o f rem o val o f a vigo ro u s an d effect ive co m p et it o r; an d t h e n at u re an d ext en t o f ch an ge an d in n o vat io n in a relevan t m arket . As n oted , sen ators felt th at th ese two assessm en ts were su fficien t. W h y m igh t co n su m ers agree o r d isagree th at two reviews are en ou gh ? Th ere are five issu es: 1. Concentration of power: Can ad ian s h ave lon g been con cern ed abou t th e con cen tration of p ower. Som e are an xio u s ab o u t t h e excessive at t en t io n elected officials wou ld h ave to p ay to th e n ew gian ts, a m atter receivin g atten tion am on g cu rren t m em bers of Parliam en t in resp on se to th e p rim e m in ist er’s p ro p o sals o n cam p aign fin an cin g. 2. Sharing the m onopoly benefits: Ho w m u ch o f t h e “valu e” sh areh o ld ers an t icip at e fro m p ro p o sed m ergers rest s so lely o n co n ven t io n al m arket m o n o p o ly? Even if gain s exist ed , co n su m ers an d sm all firm s n eed n o t see an y ben efit s fro m bigger ban ks. Prices reliab ly rise as co m p et it io n is red u ced . So m e p ro p o n en t s, wh o feel cert ain t h at eco n o m ies o f scale exist , can n o t exp lain h o w t h e red u ced co m p et it io n will in crease lo an s t o sm all bu sin ess, o r h o w it will resu lt in m o re at t en t ive service, o r lo wer ban k fees. In fact , m u ch evid en ce exist s fro m st u d ies o n ban k m ergers elsewh ere, t o sh o w t h at , o ver a cert ain size level, eco n o m ies o f scale are eit h er absen t o r u n im p o rt an t . 3. Quality: Ban ks h ave n ot been lead ers in cu stom er satisfaction . Rem em ber th at it was com p etition from an in d ep en d en t tru st com p an y th at obliged ban ks to offer better h ou rs to cu stom ers. In work I su p ervised for th e MacKay Task Fo rce, several service ch aract erist ics were id en t ified an d service levels in eigh t cou n tries were assessed . Can ad ian ban ks d o well in som e com p etitive d im en sion s su ch as tech n ology an d less well in oth ers, in clu d in g d o cu m en t clarit y. Ro ger Martin , Dean of th e Rotm an Sch ool of Man agem en t at t h e Un iversit y o f To ro n t o , u n d o u b t ed ly h as it righ t wh en h e observes th at to su cceed in in tern ation al m arkets, a firm can n ot be a com fortable oligop olist at h om e. Dem an d in g con su m ers h elp a firm ach ieve excellen ce th rou gh im p rove- Th e Gazette, Mon treal Tower above: The Royal Bank Building at Place Ville M arie in M ontreal. m en ts in q u ality. Th ere is n o evid en ce th at th e u se of h igh er reven u es from m on op olizin g m arkets at h om e will lead ban ks to su ccess in d eliverin g in t ern at io n al levels o f service. Th e con trary is m u ch m ore likely. How d o Can ad ian fin an cial in stitu tion s d o in in tern ation al m arkets? Th e evid en ce on exp orts is clear: Th e big su ccesses h ave n ot been ban kin g or t h eir in vest m en t h o u ses, b o t h o f wh ich h ave been retreatin g from a low level of in tern ation al sales. Th e win n ers are Can ad ian -b ased in su ran ce com p an ies. In 2001, Can ad ian life an d h ealth in su rers earn ed $50.2 billion , or 56 p ercen t of th eir p rem iu m s from foreign sou rces. A su rvey of service sector p erform an ce con d u cted by Can ad a’s Nation al Qu ality In stitu te fou n d ban ks 16th fro m t h e t o p o u t o f 20 service p rovid ers in 1996. In 1997, ban ks were 17t h o u t o f 21. Mo re im p o rt an t , evid en ce in d icat es t h at t h e m o re m on op olized an in d u stry is, th e lower POLICY OPTIONS M ARCH 2003 17 Robert R. Kerton it scores wh en cu stom ers assess service q u ality. Su p erior cu stom er satisfaction is th e m ost p rom isin g, th e m ost reliable, an d p robably th e only p ath to lon g-ru n su ccess. 4. Innovation: Do in vestm en ts in in form at io n t ech n o lo gy exh ib it st ro n g econ om ies of scale? For item s th at are stan d ard ized , th is is very often tru e. W h ere services h ave su btle d istin ct io n s t h at m at t er, scale eco n o m ies h ave been h ard to fin d . Th ere is a h u ge d ifferen ce between (a) loan s, wh ich n eed sp ecial in fo rm at io n , an d (b ) ban kin g m ach in es, wh ich d istribu te alread y too big to fail. Still, it is soberin g t o co n t em p lat e t h e lo sses Can ad ian ban ks m igh t h ave m ad e in th e US telecom an d tech sectors if th e 1998 p rop osals for blockbu ster m ergers h ad been ap p roved . Th e growth of ban ks relies fu n d am en tally on th e ability to offer n ew an d com p etitive services at a world level of excellen ce. To exp an d abroad , a p lau sible case exists for sh arin g m an agerial exp ertise th rou gh p artn ersh ip s with firm s abroad . To reso lve t h e issu e o f scale econ om ies it is worth wh ile to listen to sm all bu sin esses. Th is is a robu st resu lt. It m ean s th at fu rth er m ergers am on g big ban ks will m ake all sm all Can ad ian firm s less com p etitive at h om e an d abroad . Th ere is every reaso n fo r Can ad ian s to wan t to see ou r ban ks su cceed ab ro ad . Su ccess, h o w ever, m u st be earn ed in a way th at “h elp s to im p rove th e p rosp erity an d com p etitiven ess of th e n ation al econ om y,” to q u ote from th e Sen ate rep ort. Ban k m ergers m ay n o t h arm C an ad a’s biggest borrowers becau se th ey h ave access t o co m p et it ive in t ern at io n al fin an cial m arkets. Man y of th e largest corp oration s h ave There is every reason for Canadians to want to see our banks d ep lo yed “d isin t erm ed iation ” by skip p in g Can ad ian succeed abroad. Success, however, must be earned in a way ban ks an d goin g d irectly to that “ helps to improve the prosperity and competitiveness of bon d m arkets to raise fu n d s. Th e op tion is n ot available the national economy,” to quote from the Senate report. to low-in com e Can ad ian s. However, som e ru les for basic ban kin g h ave been created with stan d ard cash th rou gh ATMs. For con th e social p h ilosop h er, Yogi Berra, wh o ou t an y d irect tie to th e m erger d iscu ssu m ers, ATMs save t im e (wh ich is fam ou sly said : “You can see a lot, ju st sion s. All th at recogn ized , th e best im p ortan t), bu t in form ation tech n oloby lookin g.” available evid en ce in d icates th at m erggy also facilitates n ew an d im agin ative ers am o n g large b an ks will h arm form s of p rice d iscrim in ation . e can look at th e resu lts of all Can ad ian con su m ers an d sm all an d Th e ATM fees are a good exam p le. t h e st u d ies o f eco n o m ies o f m ed iu m firm s, in clu d in g p o t en t ial It is a bit like Mark Twain ’s claim for scale. Virt u ally all evid en ce o n exp orters. It th erefore seem s im p ossith e virtu e of fish in g at Niagara Falls: econ om ies of scale agrees th at ban ks b le t o m eet t h e Sen at e Ban kin g You d on ’t h ave to go so far to not alread y at th e size of Can ad a’s big five Co m m it t ee’s req u irem en t t h at b ig catch a fish . With ATMs you d on ’t h ave cap tu red available scale efficien ban k m ergers m u st “im p rove th e p rosh ave to go so far to get stu n g by an cies; fu rth er in creases in size offer little p erit y an d co m p et it iven ess o f t h e in n ovative fee. In form ation tech n oloor n o ad d ition al gain s. Th ere is a sin gle n ation al econ om y.” gy, esp ecially wh en u sed with d ata stu d y, recen tly in th e Canadian Journal In su m , th ere are factors im p orm in in g, allows a com p letely n ew level of Econom ics, th at su ggests th ere are tan t to th e p u blic in terest th at are o f p rice d iscrim in at io n . Un less we u n exp lo it ed scale eco n o m ies—co n beyon d p ru d en tial m atters ad d ressed d evelop a cou n terstrategy, th e in n ovatrary to all th e oth er evid en ce. Th e by OSFI, an d beyon d th ose m arket tion m erely sh ifts p ower from con research is im p ressive on m an y p oin ts issu es looked at by th e Com p etition su m ers to sellers. bu t th e m ain resu lt relies en tirely on Bu reau . Th u s, th ere is still a n eed for Man y in n ovation s are in d ep en d t h e assu m p t io n t h at t h ere is one p arliam en tary oversigh t of m erger p roen t of th e m erger issu e. However, it is national m arket wh ile m ost con su m ers p osals to en su re a ben efit to Can ad a. by n o m ean s certain th at m ergers th at an d firm s op erate in a local m arket th at red u ce com p etition can h ave an yth in g will h ave fewer com p etitors after a big Robert Kerton is a professor of econom ics bu t a n egative effect on in n ovation . m erger. Th is cru cial p oin t, local or and Dean of the Faculty of Arts at After all, in n ovation is on e com p on en t n at io n al m arket , h as alread y b een University of W aterloo. He serves as of com p etition . research ed for firm s m akin g loan s, an d chair of the Econom ics and Finance 5. Too big to fail: W h en ever bu sin esses wh at m atters is, in d eed , th e local m arCom m ittee of the Consum ers reach th e “Too Big To Fail” level, risks ket. Th e latter research fin d s th at, Association of Canada, and appeared are rem oved from in vestors an d p laced wh en oth er factors are allowed for, before both the Senate and House of on taxp ayers. Th ere is little com fort in bran ch closin gs in Can ad a are associatCom m ons com m ittee hearings on large th e retort th at big Can ad ian ban ks are ed with h igh er in terest on loan s to bank m ergers and the public interest. W 18 OPTIONS POLITIQUES M ARS 2003