Competition in the Canadian Financial Services Sector

Notes for remarks by Gilles Ménard
Deputy Director of Investigation and Research (Civil Matters)
Competition Bureau

16th Annual Convention
Canadian Association of Mutual Insurance Companies
Fredericton, New Brunswick

Monday, 30 September, 1996

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I appreciated receiving the invitation to join you here at your 16th annual convention.

As I was preparing my remarks for today I was most interested to read, in the Association's brochure, this statement:

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"The Canadian mutual insurance industry promotes a strong, healthy and competitive insurance market.

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It supports regulatory efficiency and legislative change which is in the interest of all policyholders."

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I was immediately struck by the similarities between the goals of your association and the Competition Bureau. Our principal goal is to promote strong, healthy and competitive markets and to remove inefficient and competition hindering regulations for the benefit of consumers and businesses in Canada.

I am here today to offer you comments about competition policy, competition in the Canadian financial services sector today, and the trends which are shaping competition in the coming century.

I believe that current trends in competition in the financial services sector will provide many opportunities for you to demonstrate your commitment to healthy competition and to the interests of all policyholders.

As increasing competition sweeps through your industry, those who respond quickly, develop new products and services and maintain close relationships with policyholders in their own region can be confident of prospering in the 21st century.

Today, when more and more consumers and businesses, including farmers, are using computers and are just a click away from the Internet, changes in how people do business are indeed coming.

Of course, most of you and your policyholders know well the risks and the rewards of competition.

At the outset, I would like to mention briefly the principles of competition policy in Canada today.

Competition policy is founded on the recognition that competitive market forces should act as the fundamental driving force in our economy.

Regulation which restricts competitive market forces should be the exception, NOT the norm. Why is that?

First, competition is much better than regulation in creating incentives for innovation. It is better at fostering new products, new services, new methods of doing business.

Second, competitive markets drive the prices of goods and services towards their costs of production.

Competition is better than regulation at prompting businesses to cut the costs of bringing products and services to clients. This is particularly true where rapid technological innovations ---such as the information revolution--- are sweeping through various industries.

Third, this effort to lower the costs and to respond to customers needs minimizes the misallocation of resources in the economy. It enhances economic efficiency, thus generating benefits for the entire economy.

The Competition Bureau has consistently advocated increased reliance on market forces for providing goods and services.

The Bureau has delivered this message in connection with many sectors of our economy, especially those undergoing major changes, prompted by globalization and the information revolution. These sectors include telecommunications, transportation, energy, professional services and most recently financial services.

The message that the Competition Bureau has brought to the table, in each of these cases, is always the same:

• first, it is essential to constantly re-assess the continuing need for, and the costs associated with, sector-specific regulation; and
• second, in the review of any existing regulation, the ultimate objective should be to remove the restrictions on competition as soon as possible.

Only in this way can we realize the full force of competition at work in the market, and thereby benefit all Canadians. Competitive markets will reward those who are responsive, innovative and agile. And competitive markets will put at risk those who are not responsive, not innovative, not agile. In a competitive environment, it is the market which determines winners and losers.

Now, we are all aware of the federal government White Paper released in June of this year,

1997 Review of Financial Sector Legislation: Proposals for Changes.

The White Paper discusses in some detail many of the points brought out in the presentation made by the Association of Mutual Insurance Companies to the Department of Finance in May, 1995.

The Government has made it clear that the legislative framework established in 1992 should be kept largely intact and not be subject to major changes in the 1997 round of amendments.

The White Paper announced however that the Government will establish a Task Force on the Future of the Canadian Financial Services Sector. The Task Force is to provide the Government with advice on public policy issues to advance development of a framework for the 21st century --one that will promote growth in the economy and employment. This study will shape the next round of amendments which, the Government proposes, are to take place within five years of the passage of the 1997 legislation.

The Government also believes that regulation of the payments system should be reviewed. To expedite this, the Department of Finance has established an advisory committee to study the issues. The work of this advisory committee will be an important input into the broader review by the Task Force on the Financial Services Sector.

In a sense, the payments system is the nerve centre of the Canadian financial sector.

A major challenge will be to provide market-based incentives for the efficient evolution of the system to better manage risks and, where appropriate, implement new technologies. Direct access to the system is increasingly seen as a strategic tool and as a source of competitive advantage in the marketing of a wide range of financial services.

The structure and governance of the payments system need to be reviewed, bearing in mind the following objectives:

1. promoting competition in the provision of payment services;
2. expanding access to the system by firms other than deposit-taking institutions;
3. putting in place mechanisms to ensure the optimal evolution of the system.

Our experience in the Interac matter has highlighted the importance of access to the payments system. In fact it is a strategic factor affecting competition throughout the financial sector.

The Application against the large banks which we brought before the Competition Tribunal also demonstrates the Bureau's readiness to take on the banks where necessary. Through Interac, the banks had jointly abused their dominant position in the provision of shared electronic network services used for financial services transactions. The Order of the Tribunal provides for open access to Interac and removes the impediments to competition.

The Competition Bureau looks forward to contributing to the work of the advisory committee to address the three objectives I just identified.

In addition to the payments system, the Competition Bureau believes two other areas require further review:

• the current restrictions on the business powers of financial institutions; and
• the current restrictions on foreign banks.

To most participants and observers of the financial services industry, it is clear that the direction in regulation is towards open markets. In the view of the Competition Bureau, this is the right direction.

We have seen so far the removal of most of the ownership restrictions among the financial pillars. We have seen also the broadening of the business powers of certain institutions. These developments have opened the door for a more competitive and more efficient market. Regulatory barriers, however, continue to exist.

From the strict point of view of competition policy, banks going into the retailing of insurance would be a positive development, both for the financial services sector and for consumers. It will increase competition.

Those like you, who are already in the insurance industry, have unique advantages to offer consumers. That should help you continue as a formidable force in the market. Good service, good advice ---a good personal relationship---have long been the forte of the traditional insurance agent. If most consumers continue to demand the type of service now provided by the incumbents in the industry, the insurance companies will prosper.

If most consumers demand new products, new services, new value, and insurance companies respond, they will also prosper. That will be your challenge for the years to come.

Times are changing and most people today believe that consumers and markets should determine outcomes, not regulators.

"Yes," some would say, "but what if the banks buy a dominant market share and then, acting together, use predatory practices to eliminate competitors?"

For the banks to successfully act in a predatory fashion would require them to act in concert. This is a criminal offence under our legislation that carries a maximum fine of $10 million. Such co-ordination is necessary because predatory conduct requires that the firm be able to control the amount of supply of the product that it is discounting.

Predation also requires significant barriers to entry for future entrants, otherwise a firm cannot raise prices to recoup the losses incurred while predating. Unless the firm can be assured that no one will enter and force it to lower prices later, predation is irrational corporate behaviour.

For these reasons, it is exceptional to find examples of successful predatory practices anywhere in the economy. Even the courts have recognized that what many people call predatory behaviour is really aggressive competition.

I would like to make it clear that a principal objective of our participation in the review of the financial institutions legislation is to promote open entry into all financial services markets.

This implies that not only should the banks be allowed to retail insurance, but others, including insurance companies, should be better able to compete with the banks.

The Competition Bureau advocates removing regulatory restrictions on entry into the provision of different financial services. We advocate allowing entry by all those capable of providing the service and satisfying reasonable prudential requirements.

However, in allowing entry into financial markets, entrants must be able to both access the rapidly growing electronic banking system and find an efficient way to clear and settle payments transactions.

The Interac consent order, which I referred to earlier, has gone some way to opening access to the electronic banking system. An outstanding goal for us is to ensure that all those that need to clear and settle payments transactions in order to participate in any financial market, will be able to do so on an efficient and cost effective basis. Our goal is to ensure that financial markets are open to entry and that entrants have the means to compete on an equal footing.

In addition to our role in this review, we take very seriously our role in ensuring that firms do not use their size, along with anti-competitive practices, to artificially gain market power or preserve dominant market positions.

Let me assure you that, when the time comes, when the banks will be allowed to retail insurance, the provisions of the Competition Act will be there to ensure that they do not gain an advantage through anti-competitive conduct.

Now, for a long time, many people have been concerned about concentration and dominance within the financial services sector. Two issues seem to dominate debate.

First is the question of concentration: there are only six large banks, compared to more than one hundred insurance companies.

Second is the notion of size. Much has been made of the major banks' share of the total assets of the financial sector, compared to the major insurance companies' share.

The view of the Competition Bureau is that corporate concentration and size alone are not issues of concern from a competition policy point of view.

We should recognize that other factors affect the state of competition in markets. For example, aggressive new entrants can move in and succeed over established players by offering innovative products or superior service.

As market shares crumble, incumbents must react or suffer losses. We have all seen many examples of very well-known companies which have stumbled or even gone out of business because they failed: they failed to respond to customers' demands, to introduce new products or to improve service.

This is why, around the world, competition law authorities, when determining the state of competition, focus on the ability of a party to exercise market power within a specific product market. Canadian banks may indeed have a large portion of Canadian financial assets. But what does that, in itself, tell us about whether or not they are large forces in any particular financial product.

In the Competition Act, sections dealing with mergers make specific reference to such criteria as barriers to entry, foreign competition, and substitution of other products. The Act provides that market share or concentration alone are not grounds for considering that a merger is anti-competitive.

In assessing possible anti-competitive behaviour, the Bureau examines the position of a company in each product line. Let me give you an example. Two companies may propose a merger which results in corporate concentration, producing a very large company. But in each one of, say, 50 different product lines, the merged company may or may not posses market power.

But even a dominant position in a product line, in itself, is not anti-competitive. What is anti-competitive is the abuse of a dominant position to suppress competition.

If entry barriers are low, even dominant firms will have to price at competitive levels and be dynamic and innovative. If they are not, new firms will enter and undercut their prices and fill product or quality gaps.

If customers have easy access to close substitutes, firms in concentrated markets will have to behave competitively, otherwise, they will lose their market to these substitutes.

These are the competitive pressures that keep markets honest, provide buyers with choices and sustain a dynamic economy.

There are three examples at hand of new competition arriving in Canadian banking.

Vancouver City Savings Credit Union announced recently that it is launching a new, branchless, electronic national bank. To serve customers across the country, VanCity proposes to use the telephone, automated banking machines, personal computers, the Internet and, eventually, interactive television.

This is an organization that began as a small credit union but has built up more than four billion dollars in assets based on the idea of local service and local presence.

Two weeks ago, the Federation of Saskatchewan Indians announced the launching of the First Nations Bank of Canada. The founders intend the bank, based in Saskatoon, to expand across the country.

Another source of competition facing the current Canadian banks are the foreign banks.

I-N-G, a world-wide financial services company based in Amsterdam, with $350 billion in assets, has announced plans for a new national electronic bank in Canada. As many of you know, I-N-G is already well established in Canada, in the insurance business. I-N-G, whose assets are more than 50 per cent larger than those of the Royal Bank of Canada, is to join the Hongkong Bank group, another international giant, as a competitor in Canadian banking.

With developments like this, we may very well see a significant increase in competition in Canada from foreign banks. There has been some progress in removing restrictions on foreign banks but much remains to be done.

In conclusion:

The fundamental force driving our economy should be the competitive market, which drives the prices of goods and services towards their costs of production.

The costs of goods and services are very much on the minds of consumers in Canada. The consumers no doubt will deal with the insurer which provides the best prices as well as the best service, the best advice ---the best personal relationship.

In a new world of electronic commerce, the dynamic, local, personal relationship may be the most formidable weapon in dealing with giant new players attempting to sweep in new clients by computer.

And there is little to prevent anyone, including you, from providing both local, personal services and electronic services at the same time.

On this, I would like to thank you for your attention. I am available to answer you questions.