5 Empirical evidence

Note: RBC = Royal Bank of Canada CIBC = Canadian Imperial Bank of Commerce, BMO = Bank of Montreal, BNS = Bank of Nova Scotia (Scotiabank), TD = Toronto-Dominion Bank.

Source : Data compiled independently by the authors using information from the annual reports of the Big 5 banks and Regional financial institutions in the lower mainland of British Columbia as well as from financial directories for greater Vancouver.

Using a 50 percent rationalization ratio results in a net decrease in the number of Big 5 branches in greater Vancouver of 41.40 percent. The analysis must be extended beyond the reduction in the number of Big 5 branches in order to account for the introduction of alternative financial institutions ranging from small, regional banks (both Schedule I and Schedule II) to local credit unions to national non-financial institutions such as mutual fund companies. Table 15 presents five financial institutions that currently compete with the Big 5 banks in the greater Vancouver region. Two of the five financial institutions presented in table 15 dominate three of the 12 regions analyzed in greater Vancouver. Surrey Metro Savings has more branches in both Langley and White Rock than any other financial institution and also effectively competes in its home market of Surrey-Delta. Similarly, Richmond Savings dominates the Richmond market with more branches than any competing financial institution.

The smaller, regional financial institutions are using the proposed mergers to market themselves more aggressively as a direct alternative to the Big 5 banks and two have recently undertaken major advertising campaigns in the greater Vancouver region. Richmond Savings' campaign refers to gaining relief from the ``humungous banks'' while Westminster Savings refers to the ``Cure for the common bank.'' In addition, many regional and niche financial institutions have traditionally, although not as aggressively, marketed themselves as direct alternatives to the banks. Rather than viewing the possibility of consolidation as a hindrance to future market opportunities, institutions like Richmond Savings and Westminster Savings have seized upon the market change as an opportunity for growth.

The data in table 15 is deficient in that it only views geographic competitiveness. One of the major strengths of smaller, local firms is their ability to carve out specific niches within larger markets. Table 16 summarizes the number of alternative financial institutions, both large and small that exist in direct competition with the banks in the greater Vancouver region.

Table 14 : Projected number of branches in greater Vancouver after mergers

Region

RBC / BMO

CIBC / TD

BNS

Total

Change in the Number of Big 5 Branches

Burnaby

Coquitlam

Langley

Maple Ridge

New Westminster

North Vancouver

Port Coquitlam

Richmond

Surrey-Delta

Vancouver

West Vancouver

White Rock

Total

184

-37.93%

-40.00%

-45.45%

-50.00%

-41.67%

-42.11%

-50.00%

-45.45%

-39.58%

-40.00%

-50.00%

-42.86%

-41.40%

Note: RBC = Royal Bank of Canada CIBC = Canadian Imperial Bank of Commerce, BMO = Bank of Montreal, BNS = Bank of Nova Scotia (Scotiabank), TD = Toronto-Dominion Bank.

The breadth and variety of financial services offered by the firms highlighted in both tables 14 and 15 is large. Traditional bank services as well as unique, niche services are provided by the firms contained in both tables in direct competition with the Big 5 banks. The range of services include venture capital financing, mortgages and loans, financial planning, mutual fund products, specialized sale of securities and commodities, traditional savings products, and leasing.

Tables 13 through 16 illustrate the need for a view of financial services broader than the narrow concept of banking.18 Bank services are but one aspect of a larger and more dynamic market for financial services. In order accurately to analyze the effect of a merger within this industry, the total financial services market must be assessed. It is clear that there are many firms competing for geographic markets and in specific niches that can and will continue to compete with the larger banks.

Table 15 : Financial institutions in greater Vancouver competing with traditional banks

Name Type Region Number of Branches

Surrey Metro Savings Credit Union Langley 4

Surrey-Delta 7

White Rock 3

Hong Kong Bank of Canada Schedule II Chartered Bank Burnaby 3

Langley 1

Maple Ridge 1

North Vancouver 2

Richmond 5

Vancouver 17

VanCity Credit Union Burnaby 5

Surrey-Delta 5

Vancouver 17

Richmond Savings Credit Union Richmond 7

Canada Trust Trust Company Burnaby 4

Coquitlam 2

Richmond 5

Vancouver 12

West Vancouver 2

White Rock 1

Defining product markets: case study of Canadian fixed-income mutual funds

The final segment of this section of the report discusses theoperational difficulties associated with defining a product market. The Competition Bureau applies specific criteria to determine whether a merger will be reviewed for its effects on competition. Underlying these criteria is the assumption that product markets, like geographic markets in the previous section, can be readily and appropriately defined. Any deficiency in the preliminary definition of a market will therefore necessarily lead to a subsequent deficiency in the analysis of the effect of a merger on market competition.

Canadians, and indeed North Americans in general, have made a pronounced shift to mutual funds from the traditional instruments of savings such as deposit certificates and savings accounts. The total assets invested in mutual funds stood at over $328 billion dollars as of May 1998.19 In other words, the value of the total amount invested in mutual funds is almost 38 percent of the total value of all goods and services (GDP) produced in Canada last year.

We used a sample of 22 mutual fund companies operating in Canada.20 The sample encompasses the 15 largest mutual fund companies, including all of the Big 5 banks. The mutual funds were divided into 12 separate categories.21 Only one of the 12 categories--Canadian Fixed Income--will be presented in the body of the paper but data for four of the remaining 11 categories is presented in Appendices E(1) through E(4).

The progression of the following five tables illustrates the effect that a successive broadening of the product definition can have on the respective market shares. To reiterate, it is the market share of the consolidated firms that the Competition Bureau analyzes to gauge the effect of a merger. It is the extent of the market definition that determines the market shares of the participants--a broader definition necessarily decreases each participant's market share; a narrower definition necessarily increases it. As illustrated in the following tables, a narrow product definition results in a high market share, which suggests that negative effects may result from consolidation. However, a broader product definition diminishes the market share of each firm to the point where there is little or no market power after consolidation.

Canadian fixed income mutual funds

The fixed income component of any portfolio can consist of a number of different types of mutual funds including dividend, bond, and mortgage. We initially defined the product market as including only Bond funds. Table 17 shows a narrowly defined market--bond funds--that will be progressively expanded in order to illustrate the effect of a broadening product definition. Table 17 contains market share information for bond funds provided exclusively by the Big 5 banks.

Table 16 : Alternative niche firms in greater Vancouver

Type of Institution

Number of Individual Firms

Range of Branches per Firm

Schedule I Banks (other than the Big 5 banks)

Schedule II banks

Trust Companies

Credit Unions

Finance

Financial P;Planners

Mutual Funds &Brokers

Stock & Bond Dealers

156

2-4

1-3

1-6

1-46

1-2

1-3

1-6

1-3

Note : Duplication and overlap between subsidiaries and parent companies was largely eliminated in the analysis of the number of firms and branches.

If the market is initially defined narrowly, that is, in terms of funds provided exclusively by the Big 5 banks, the market appears to be highly concentrated. There are only four firms providing four separate products. The Royal Bank of Canada prior to a merger with the Bank of Montreal, given the narrow market definition, accounts for 44.01 percent of the entire market. Assuming the merger occurs, the post-merger firm of the Royal Bank of Canada and the Bank of Montreal would control 71.35 percent of the consolidated market.

As there are obviously other companies providing similar mutual funds, Table 18 expands the product definition to include Bond funds provided by any chartered bank in the sample.

Table 17 : Canadian fixed income bond funds from the Big 5 banks

Name of Company Name of Fund Market Share*

1 Bank of Montreal 1 Bond Fund 27.35%

2 C.I.B.C 2 Canadian Bond Fund 13.20%

3 Royal Bank of Canada 3 Bond Fund 44.01%

4 TD greenline 4 Canadian Bond Fund 15.44%

* Market Share refers only to those companies included in the table; it does not, therefore, represent the market share for the entire category or the mutual fund industry.

Source : Data compiled independently by the authors using information from the annual reports, websites, and data requests from the various mutual fund providers.

By simply extending the product definition to include all chartered banks in the sample, the number of competitors increases by 50 percent, from 4 to 6 firms. The largest firm now represents 39.45 percent of the market share, down 11.56 percent from its previous high of 44.01 percent. Similarly, the effect of the proposed merger between the Royal Bank of Canada and the Bank of Montreal is reduced. The post-merger firm now accounts for 63.97 percent of the market, down from 71.37 percent when the market was more narrowly defined.

There are a number of non-financial institutions that deal almost exclusively in the provision of mutual funds. Templeton, Investors Group, and Fidelity are three examples of large mutual fund providers in Canada that are not classified as banks. Table 19 contains market share information for all providers of bond funds in the sample. Note that we have excluded specialty bond funds from table 19 in order to maintain homogeneity amongst the mutual funds contained in the table. That is, by maintaining a narrow definition of the product, Canadian Bond funds, there is a great deal of similarity among the funds provided by the various companies included in table 19.

Table 18 : Canadian fixed income bond funds from all financial institutions*

Name of Company Name of Fund Market Share*

1 Bank of Montreal 1 Bond Fund 24.52%

2 Canada Trust 2 Bond Fund 9.14%

3 C.I.B.C 3 Canadian Bond Fund 11.84%

4 Hong Kong Bank of Canada 4 Canadian Bond Fund 1.20%

5 Royal Bank of Canada 5 Bond Fund 39.45%

6 TD greenline 6 Canadian Bond Fund 13.84%

*Restricted to the original sample that excludes smaller companies and segregated mutual funds.

** Market Share refers only to those companies included in the table; it does not, therefore, represent the market share for the entire category or the mutual fund industry.

Source : Data compiled independently by the authors using information from the annual reports, websites, and data requests from the various mutual fund providers.

Table 19 : All Canadian fixed income bond funds (excluding specialty bond funds)*

Name of Company Name of Fund Market Share**

1 AGF Group of Funds 1 Canadian Bond Fund 8.28%

2 Altamira Investment Services Inc. 2 Bond Fund 4.56%

3 Atlas Mutual Funds 3 Canadian Bond Fund 0.51%

4 Bank of Montreal 4 Bond Fund 17.04%

5 Canada Trust 5 Bond Fund 6.35%

6 C.I Funds 6 Canadian Bond Fund 1.56%

7 C.I.B.C 7 Canadian Bond Fund 8.23%

8 Fidelity Funds 8 Canadian Bond Fund 1.30%

9 Global Strategy Investment Funds 9 Bond Fund 0.19%

10 Hong Kong Bank of Canada 10 Canadian Bond Fund 0.84%

11 Investors Group 11 IG Sceptre Canadian Bond Fund 0.09%

12 Mackenzie Financial Corp. 12 Industrial Bond Fund 5.56%

13 Royal Bank of Canada 13 Bond Fund 27.42%

14 Sagit Investment Management Ltd. 14 Trans-Canada Bond Fund 0.01%

15 TD greenline 15 Canadian Bond Fund 9.62%

16 Templeton 16 Canadian Bond Fund 0.39%

17 Trimark Mutual Funds 17 Advantage Bond Fund 6.53%

18 Canadian Bond Fund 1.52%

*Restricted to the original sample that excludes smaller companies and segregated mutual funds.

** Market Share refers only to those companies included in the table; it does not, therefore, represent the market share for the entire category or the mutual fund industry.

Source : Data compiled independently by the authors using information from the annual reports, websites, and data requests from the various mutual fund providers.

Broadening once more the definition of providers results in an increase in the number of firms to 17, with a total of 18 products offered. One of the interesting facts that can be derived from the table is the recognition of both interfirm and intrafirm competition. Interfirm competition refers to the standard type of competition that exists between two separate companies. Intrafirm competition refers to competition that occurs within a company. For instance, separate departments within the same company may compete for staff or budgetary resources. In the mutual fund sector, intrafirm competition results from the presence of two similar or substitutable products offered by the same firm. Customers of one company would be able to choose between more than one product from the same company. Each fund would compete with the other funds the firm offers for its customers. Intrafirm competition is illustrated by the Trimark example in table 19. Trimark International offers two separate funds within the same category. This effectively means that the two funds will compete for the same group of clients within their own company as well as with other, external, mutual fund sector competitors. Thus, two distinct types of competition exist within the mutual funds sector.

Interfirm competition--competition between separate companies--obviously increases as the number of firms increases. Under this broader market definition, the number of firms offering a similar product increases by 183 percent, from 6 to 17 firms. The market share of the largest firm in the market is again reduced from the previous level of 39.45 percent to 27.42 percent, a 43.87 percent decline in market share. The effect of the merger between the Royal Bank of Canada and the Bank of Montreal is further reduced as the market share controlled by the post-merger firm decreases to 44.46 percent from a high of 71.35 percent.

Table 20 further broadens the product definition by including specialty bond funds.22 Specialty bond funds focus either on a particular duration or maturity, such as short or long term bonds or they focus on a particular type of bond, such as corporate bonds.

Again broadening the product definition increases the number of providers marginally to eighteen, adding one more company. The number of funds offered, however, increases by 61 percent, from 18 to 29 funds. The single largest market share is reduced to 18.65 percent from a high of 44.01 percent. The post-merger market share of the Royal Bank of Canada and the Bank of Montreal has also decreased: the post-merger firm would now control only 30.24 percent, down from its original high of 71.35 percent. Intrafirm competition has also increased, as the number of firms offering more than one bond fund increased eightfold from one to eight firms.

Portfolio management is basically concerned with the allocation of investment resources amongst competing alternatives. In general, a portfolio manager will allocate a certain percentage of funds to each of the following categories: cash and cash equivalents, fixed income and equities.23 Table 21 expands the product definition to include all types of bond funds provided by the sample companies. However, it does not expand the product definition to include competing alternatives within the fixed income category. A number of mutual funds would compete directly with bond funds for the resources allocated to the fixed income segment of a portfolio. These mutual funds would include income, dividend, and mortgage funds. Table 21 includes market share information for all the funds from the sample companies categorized as fixed income.

The broadening of the product definition again results in the number of funds expanding significantly. The number of funds included in the Canadian Fixed Income category increases by 148 percent, from 29 to 72 funds. Similarly, the number of firms offering products in this category increases by 22 percent, from 18 to 22 firms. The fund holding the largest market share now controls only 6.67 percent of the market, down 84.84 percent from its original high of 44.01 percent. Similarly, the post-merger firm of the Royal Bank of Canada and the Bank of Montreal now account for only 25.58 percent of the entire fixed income category of mutual funds.

The process of broadening the definition of the product market could again be undertaken to include products that would compete directly with fixed income mutual funds such as guaranteed income certificates, government and corporate bonds, and high yield dividend stocks. Alternatively, the product definition could be expanded further to include all categories of mutual funds, as a specific product in competition with other general types of financial products such as savings accounts. The overall effect of broadening the product market definition is clear: reduced market power for the participants and an increasing level of both interfirm and intrafirm competition.

There is no clear analytical rule for narrowly or broadly defining a particular product market. However, the availability of substitute products that closely approximate the original product should be an indication of the appropriate product market definition. It is evident that for the financial services market, a wide definition of the product market should be used in order to include all the institutions that offer a close substitute for a particular product.

Click here to view Table 20 : All Canadian fixed income bond funds Including specialty bond funds*

Click here to view Table 21 : All Canadian fixed income funds*

Foreign competition

One of the interesting aspects of the data contained in tables 17 through 21 is the lack of foreign competitors in the mutual fund industry. Only two of the top 15 mutual funds in Canada (measured by asset size) are foreign: Templeton and Fidelity. Likewise, none of the Schedule I, chartered banks are foreign. The reason the mutual fund industry lacks foreign competitors is the same reason none of the major banks in Canada are foreign: government regulation.

It is not the intent of this particular report to discuss the pros and cons associated with regulation.24 Regulation in the financial services industry controls and defines the participants and the level of competition between them. For example, federal regulations regarding foreign banks operating in Canada place foreign institutions at a distinct disadvantage to their Canadian competitors. Foreign banks are prohibited from using the capital of their parent company to finance operations in Canada. Put another way, foreign competitors are forced, by regulation, to raise capital within Canada even if they maintain sufficient capital abroad to establish operations.

Although this regulation may seem to have only a marginal effect on cost, when combined with other foreign restrictions the net result is a competitive cost disadvantage for foreign companies based solely on the imposition of regulation by the federal government. Perhaps the single greatest cost from regulation derives from the requirement of subsidiary status for foreign companies. Foreign firms are required by regulation to establish a Canadian subsidiary rather than operate simply as a branch of a parent company. Foreign financial institutions cannot, therefore, simply open an office in Canada. They must establish a separate company, with its own capital, management, and reporting structure. All of these regulatory requirements result in additional costs to the foreign company that would not be necessary if they operated as a branch.

In assessing the likelihood of heightened foreign competition, it is essential to recognize that the lack of a large-scale entrance to the Canadian financial services industry by foreign companies is largely due to the barriers--the regulations--imposed on them by the federal government. Mathewson and Quigley (1998) suggest that removing the barriers to entry for foreign financial and non-financial institutions in order to allow them to compete directly with Canadian financial institutions would ensure that the gains from consolidation flow through to the customer. Further, the evidence on the concept of contestable markets suggests that the removal of barriers themselves will facilitate behaviour that approximates a competitive market.

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Last Modified: Wednesday, October 20, 1999.