This article was originally published in Maclean's Magazine on December 28, 1998
On the face of it, Paul Martin's personal invitation seemed gracious. The federal finance minister had set out to do what Royal Bank of Canada chairman John Cleghorn had refused to do for Martin last January - provide Cleghorn with a heads-up warning about what was happening with his company's plan to merge with Bank of Montreal. Not only was Cleghorn the first of the four pro-merger bank chairmen invited to attend a private meeting with either the minister or representatives of the finance department, his status as Canada's most influential banker, as well as his personal relationship with Martin, meant Cleghorn was invited to visit Martin at his home in Montreal for a Sunday chat on the afternoon of Nov. 29.
Banking and government sources both say Martin did his utmost to be diplomatic. He did not want to appear to have made up his mind, given that the federal competition bureau would not deliver its report on the mergers for almost two weeks, but he also wanted to prepare the banker for bad news. Like everything else arising from this year's ill-fated bank mergers, however, this meeting between two of the most powerful figures in Canadian finance went off the rails fairly fast. For weeks, Cleghorn's fuse had been growing shorter as his frustration mounted over Canadians' inability to understand the bankers' point of view. In response to Martin's evasiveness, something apparently snapped. Cleghorn asked straight out whether the Royal's merger with the Bank of Montreal, and the Toronto Dominion Bank's copycat arrangement with the Canadian Imperial Bank of Commerce, were going to be allowed to proceed. "No," Martin said simply. Cleghorn, according to both banking and federal government sources, said something along the lines of "No, but . . . ?" or "Unless what?" Martin repeated his first answer. "No."
This was when the usually composed banker lost it, according to government officials. Watching a year's work sacrificed to what the bankers see as political expediency and parochialism was apparently too much to swallow. His face grew red and he pounded the table, while giving the minister an earful.
For once in his life, Martin remained ice-cool. As Cleghorn gave vent to his complaints, all the finance minister said was: "John, you're not listening to me." Sources close to Martin say he repeated this phrase several times before Cleghorn calmed down.
Cleghorn - the man whose surprise visit to his Bank of Montreal rival Matthew Barrett's 1997 Christmas party triggered this round of merger proposals - is once again out in front of the pack. He may be the only banker in Canada with the connections and clout to direct the full force of his disappointment and outrage at the finance minister in person. But he is far from the only one who is angry and bitter over Martin's staggering Dec. 14 announcement that the bank mergers, as proposed, are dead - at least until the government completes its sweeping review of the financial services sector, a process that will not end until some time in early 2000.
In one swoop, the finance minister made it clear that government, not business, will decide what shape the country's banking sector is allowed to take in the years ahead. And while there is still hope that the bankers will find a way to patch up their relations with Martin in time to work together on the new blueprint for their businesses, Cleghorn's meeting with Martin makes something else clear: the big banks are not going to take it any more. They will defer to Martin's decision - senior bankers say that under the Bank Act, they don't have much choice - but they are determined not to wait around to see what next year's regulatory review will bring. Exactly what the banks will do, nobody can predict at this time. The way they feel right now, most senior Canadian bankers would gladly have traded their Christmas bonuses to have been in Cleghorn's place. (Bank of Nova Scotia chair- man Peter Godsoe - the only chairman among the Big Five without a potential partner - is the odd man out. He commended the government on its effort to do a thorough job of assessing the financial sector and told Ottawa to feel free to call on Scotiabank should it ever require any help.)
In their own words, bankers spent last week "licking their wounds" - not a bad analogy, given the fact that every major banking executive in the country went to ground and stayed there. Bank executives have refused to provide any public comment beyond a few terse statements officially calling the mergers off. (The TD and CIBC wasted no time, making separate announcements the morning of Martin's decision; the Royal and Bank of Montreal gave it 24 hours before following suit the next day.)
But behind the scenes, they are seething - and complaining loudly. One banker likened the process of seeing the competition rulings made public to having "open-heart surgery on The Learning Channel so everybody can watch and say, 'Ooh, look at all the blood here.' " Another warns that while Canadians might think they hate bankers now, they have not seen anything yet. "They're going to like it even less when they're stuck dealing with American institutions," he grumbled, arguing that Martin's decision to postpone merger talks until after the federal government completes its lengthy review of the financial services sector means there will be no Canadian banks left by the time the Liberals get around to letting them join forces.
Some are even more apocalyptic. "So, how do you think you'll like living in Indonesia?" asked one senior banker, suggesting that any country that rejects bank mergers is somehow headed for dictatorship and financial chaos.
When they tone down the hyperbole and theatrics, the bankers make some interesting points. They question the way Konrad von Finckenstein, head of the competition bureau, handled the crucial matter of whether the banks would be allowed to propose remedies to serious concerns that have been raised about post-merger concentration of such financial services as credit cards, brokerage subsidiaries and the monopoly of retail branches in certain provinces. Von Finckenstein is on the record saying the banks would have to wait until the bureau was finished its review before offering their solutions, yet he suggested in a news conference last week that the banks were unwilling or unable to respond. "Our review was open from Day 1," he said in Ottawa. "And as we discussed problems with them on such issues as branch banking, they could have started to think about those and offer solutions. They never did so."
Bank officials angrily denied they were given a chance to propose detailed solutions to the bureau's findings. "Nobody expected it to be such a clean kill," says the top competition expert with one of the disappointed banks. Bankers are, however, reluctant to challenge von Finckenstein's version of events. One senior bank official cited the need to maintain good relations with the bureau in case the mergers are ever revived, or any other future mergers and acquisitions come under von Fickenstein's purview.
Future relationships with customers, on the other hand, are a different matter. The sheer magnitude of bank managers' indignation raises a key question: Now what? Are Canadians really in for a taste of scorched earth - laying-off employees and closing branches as they focus on more profitable business segments - as the merger advocates began warning this fall? In the insurance industry, there is strong speculation that Ottawa will award the banks consolation prizes such as hefty slices of the insurance and auto leasing markets. "All we know for sure is that 1999 is going to be an interesting year," a senior Royal Bank official says in an ominous tone of voice. "Oh, right," countered a cynic in the bank's brokerage arm. "The banks are going to cut back on customer service. And how are we going to notice that?"
Jokes aside, there is one overworked slogan from this debate that will come to pass: the status quo really isn't an option. No Canadian bank is going to sit still and wait to see what 1999 brings; they simply cannot afford to - especially in light of what the investment community considers to be middling-to-rotten financial performance by the pro-merger banks. (Only Scotiabank, its numbers adjusted to exclude special gains in 1997, garnered a handful of rave reviews for its 1998 results.)
Although the Big Five all reported 1998 profit of more than $1 billion, both growth and return on equity - a ratio that measures how well each bank manages its money - fell substantially over the course of the year. Bank stocks have all taken a shellacking; most are down roughly 30 per cent from midsummer levels. This year's global financial upheaval, and its impact on profitability, is the biggest factor - particularly at banks such as the CIBC and Bank of Montreal.
Stock market analysts and bond raters are putting fierce pressure on Canadian banks to show that no matter what Ottawa says or what goes on in world financial markets, they can still post a healthy profit and show year-over-year growth. Fund managers, for example, are reminding the banks of their claims during the merger debate that they need to chop as many as 20,000 of 150,000 jobs among the four banks to stay competitive. And on Friday, New York City-based Standard and Poor's, a credit-rating agency, upped the ante substantially by revising its outlooks for both CIBC and Bank of Montreal from stable to negative, and warning other Canadian banks that they must rethink their business strategies or face possible ratings downgrades. (On a bright note, S&P offers up a useful tidbit for customers accustomed to hearing bank honchos gripe about what those retail customers cost the banks: Royal's consumer-oriented focus is the reason S&P ranks that company above the rest. What's more, Bank of Montreal and CIBC's branch networks are cited as sources of growth and stability in the midst of otherwise volatile business mixes.)
Canadian consumers are already getting the odd glimpse of what's in store for them. The most striking example is TD's experiment in what one of its senior executives calls "decoupling" - an effort to make tellers available to customers who purchase banking products such as mutual funds and GICs, while posting signs informing those who wish to conduct conventional banking transactions that they must use a bank machine or return during a designated time period.
In addition, in response to what the bank says was customer demand, TD launched two "service centre" pilot projects in the Toronto area in mid-November. The fully staffed service centres are open 14 hours a day, seven days a week; meanwhile, in each case, four or five nearby neighbourhood branches have been downsized to kiosks that provide tellers for two-hour periods, two days a week. Depending on feedback, these service centres could eventually stretch across the country.
While the banks may cut back locally, they are all looking for profitable niches around the globe. Royal bought an Atlanta-based Internet bank last spring and throughout the fall acquired various private banks - including the prestigious Channel Islands banking operation that provides offshore financial services to blue bloods like the British Royal Family. Late last week, it picked up a New York discount brokerage called Bull & Bear Group Inc. as a base for building a major U.S. discount brokerage arm. Royal plans to compete with Toronto Dominion subsidiaries Green Line and Waterhouse Investor Services, as well as giant Charles Schwab & Co. Inc. of San Francisco.
Coincidentally, Schwab, the industry leader in online brokerage, made its first foray into Canada last week with its purchase of two small Canadian investment dealers, Priority Brokerage and Porthmeor Securities, that Schwab plans to combine to create Charles Schwab Canada - a development that Canadian bankers seize on as further proof that their fears of being swamped by big foreign players are coming true. They predict that before long, competitors like Schwab will prod Canadian banks into merger agreements that will create a great deal more trouble for Ottawa than the ones Martin rejected this month. Federal ownership rules prevent any one party from holding more than 10 per cent of a chartered bank. Yet nothing but the finance minister's discretion stands between the banks and a merger with a widely held foreign entity like New York's Citigroup, Germany's Deutsche Bank AG, or ING Groep of Holland. One hot rumour involves a possible joint venture or other business link between Scotiabank and Wells Fargo & Co., of San Francisco. "The lawyers have already worked out how to do this," the competition expert says. "You just move the legal headquarters to Canada. Can you see a U.S. company taking no from Paul Martin? They'll just take him to court under NAFTA."
In the meantime, as many as three out of four Canadian banks will be forced to grapple with the question of whether their internal shake-ups should start at the top. Starting next week, the banks will begin releasing their annual reports and with them information circulars revealing salaries and bonuses paid to CEOs for the 12 months ended Oct. 31. Are their services still thought to be worth the millions they receive? Time - and board meetings scheduled at various times in early 1999 - will tell. TD directors are happy with the leadership of chairman Charles Baillie and the deft way he moved the bank in and out of the proposed merger with CIBC. On the other hand, CIBC directors will be forced to resume their search to replace Al Flood when he retires, now that Baillie won't be heading up a united TD-CIBC.
Bank of Montreal's Barrett was also on the verge of stepping down in favour of Cleghorn, but is now thought likely to leave the bank even sooner than he might have under the merger agreement - and perhaps not in the stylish manner he had envisioned.
Cleghorn is being pegged as the one to watch. Friends and colleagues say they cannot imagine what Royal directors might have expected him to do differently over the past year. "The directors approved it, and they knew all along it was not going to be a slam dunk," one says. However, sources close to the board say Canada's most powerful, successful and influential banker could be compelled to fight for his job in the months ahead.
A New Vision for Financial Services
Stopping the mergers was the easy part. Armed with a half-dozen reports from parliamentary committees, task forces and federal regulators, Finance Minister Paul Martin found plenty of reasons to turn down the banks. But some of those same reports are full of contentious recommendations, which, if Martin acts on them, would amount to a bold, politically risky reform of banking law. Foreign banks would play a bigger role. Credit unions would expand. Eventually, other companies, such as retail store chains, might set up their own banks. "The whole uproar around the mergers was a signal that this industry is going to go through enormous changes," says Bill Knight, president and chief executive officer of the Credit Union Central of Canada. "It's not just talk, it's reality."
But are consumers ready for a new vision? While the experts who have studied the banking system tend to favour a more freewheeling financial services marketplace, many consumers value security above all else. Canadians often resent their stolid banks, but they also feel safe with them. A poll for Maclean's by Northstar Research Partners found that 60 per cent of Canadians have a positive impression of the current banking system.
That hardly amounts to a clamour for change. Still, Martin has left no doubt he sees too much power concentrated in the big banks' boardrooms and wants to give Canadians new banking choices. To that end, finance department officials are working on three main policy thrusts:
Martin is ready to table legislation as early as February to make it easier for foreign banks to open branches here. They are now required to set up Canadian subsidiaries with enough assets to back up any deposits they take in at Canadian branches. Under the proposed changes, a foreign bank could open branches in Canada without establishing a Canadian subsidiary. Such branches would be allowed to accept only deposits over $150,000 - limiting them to business banking.
Knight says federal law should be amended to let credit unions combine forces to offer new nationwide services. But credit unions come largely under provincial jurisdiction, so Ottawa would have to negotiate changes with the provinces. If they succeed, customers might get more bank-like services when they travel outside their home communities, such as being able to make deposits at the automated bank machines of other credit unions. More importantly, credit unions want to be allowed to combine forces to offer business lending on a bigger scale.
Perhaps the thorniest issue facing Martin is how to coax new owners into the banking business. The current law allows no individual or group to own more than 10 per cent of a bank - a major barrier to any company trying to set up a new one. The federal task force headed by Regina lawyer Harold MacKay called for a much more flexible regime. The 10-per-cent limit would still apply to big banks, but smaller banks could be controlled by other corporations. MacKay suggested, for example, that a major retailer should be allowed to set up a bank. Federal officials said the earliest a new framework policy on ownership could be drafted would be late 1999.
Maclean's December 28, 1998