Let banks and insurance companies merge: C.D. Howe report

By Bryan Borzykowski | June 28, 2007 | Last updated on June 28, 2007
5 min read

If the CD Howe Institute had its way, insurance companies and banks would be able to merge. The think-tank issued a report Thursday, calling for such changes.

The 32-page document says cross-pillar integration would help Canadian financial intuitions “expand the scope of their operations and realize potential economies.”

Both the Canadian Bankers Association and Advocis declined comment on the report, but Ian Russell, president and CEO of the Investment Industry Association of Canada, believes the insurance institutions and banks should be allowed to join forces. “Cross pillar merges shouldn’t be discounted out of hand,” he says. “As long as competitive implications can be addressed — and I think there are remedies that can be put in place to address these concerns — it should be allowed.”

According to the report, there’s a “strong” case to let banks distribute insurance products using their branch networks. “Prohibiting cross-pillar mergers severely limits the extent to which Canadian banks and insurance companies can follow the ‘bancassurance’ model that is becoming more prevalent in Europe and the United States.”

There are some issues related to bank and insurance mergers that need to be addressed, says C.D. Howe. One is there’s a lack of clear evidence for economies of scope between the two financial institutions. But instead of blocking mergers, the think-tank says managers and shareholders should be left to assess potential efficiency gains.

Another concern is that a merger between the two sides could adversely affect the financial sector. The report says this isn’t much of a concern for life and health insurance companies since they mainly sell savings products, but mergers between banks and property, casualty and re-insurance companies “could lead to a significant increase in the aggregate risk of banks.”

To solve this problem, C.D. Howe says ex-post provisions need to be put in place to limit the exposure of a company to “large, aggregate risk from the insurance business.” Companies could also be limited in how much of these types of insurance they could sell, or business that do have a lot of these risks could be prevented from becoming part of the banking sector. “This would leave banks free to participate in areas of the insurance sector that do not have large aggregate risk components,” says the report.

Bank and insurance mergers wasn’t the report’s only focus. The institute also called out the government for missing an opportunity to allow the banks to merge themselves.

“The federal government’s most recent legislative reform in the financial sector … sidestepped significant change,” says the report. “This is unfortunate because Canada urgently needs regulatory reform that would allow for the creation of a new competitive regime for financial services.

“Banks should be allowed to merge as part of a larger strategy of realizing further efficiency gains and risk reductions mainly through internationalization of their operations.”

Russell adds that Canada’s banks are suffering without the power to merge. “They’ve let this problem languish for 10 years,” he says, “and damage has been done to Canada’s position in global services banking.”

Eleven years ago, the Bank of Montreal and the Bank of Scotland were the same size, Russell notes. Today, the Bank of Scotland is four times bigger than BMO, with a market value of $126 billion. To make matters worse for Canadian banks, BOS is currently in merger talks with Netherlands-based bank ABN Amro. “That could have been a Canadian company,” says Russell. “But we lost out on that opportunity.”

And that’s C.D. Howe’s main point — without Canadian bank mergers, we’ll lose out as global competitors. According to the institute, things are starting to look bleak. It says that RBC’s global rank, in terms of market cap, was in a top 40 position in 1990, but 10 years later, it was below 50. “If anything, this understates the decline in their size compared to the 10 largest banks, which have grown rapidly in size via mergers and acquisitions,” says the report.

Still, some Canadian banks have penetrated international markets, but because of their relative small size, C.D. Howe says any progress outside of Canada is mainly due to local businesses that deal with the banks abroad. “None of the Canadian banks seems to be of a sufficiently large size to seriously compete either with globally operating European banks or even with the leading U.S. banks for cross-border business arising from multinational corporations.”

C.D. Howe makes a good case for mergers, so why is the government stalling? One reason could be an over saturation of branches, which would force many of them to close and people to lose jobs. Both the institute and Russell don’t think this would be the case.

“There wouldn’t have been massive closures of bank branches,” says Russell. “If BMO and Royal Bank would have merged (in 1998) and if there would have had undue concentration of banking in a particular community, those branches would have been packaged and sold to a third player. There were some smaller banks that were very interested in buying branches from a merged entity. Services would have continued and banking would have stayed competitive.”

The report says branch consolidation already happened between 1997 and 2004 — the total number of branches fell from 6,600 to 6,200 — so it’s not a sure bet that further cuts would take place.

Plus, increased competition from Internet banks and other smaller players would pop up, creating more services. “It’s not clear that fewer branches in the wake of a merger would have a significant adverse impact on access and competition,” says the report. “(There would be) increased competitive pressure from new players . . . such as PC Financial and Canadian Tire Bank.”

For bank merger advocates, this report could provide increased ammo when and if the debate resumes in parliament. C.D. Howe thinks it will be a while, though, saying the government’s recent legislative reform “does not generate much optimism” for changes in the near future.

But if something’s not done soon, the institute warns that Canada’s financial sector could be in serious trouble. “As financial markets are becoming more globally integrated by the minute, pressure is mounting for the whole Canadian financial system to keep pace with this trend.”

Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com


Bryan Borzykowski