Introduction

The
Economic Freedom
Network

Introduction

The decision on the bank mergers will be made by this government, by this Parliament, and by the Canadian people. It will not be made by any financial institution. Anybody who has doubt about that had better just watch us.

Paul Martin, Minister of Finance
Ottawa Faces the Big Squeeze
Maclean's, May 4, 1998: 22

Jobs are certainly the government's concern and I have made it clear that they will be at the top of the agenda.

Paul Martin, Minister of Finance
Competition a Must if Banks Merge
Financial Post, June 3, 1998: 7

This would not be allowed in Britain or in the United States. Any other country would consider this anti-competitive.

Peter Godsoe, Chairman, Bank of Nova Scotia
Is Bigger Really Better?
Maclean's, May 4, 1998: 16

Recent proposals to merge (1) the Royal Bank of Canada and the Bank of Montreal, and (2) the Canadian Imperial Bank of Commerce and the Toronto Dominion Bank have sparked considerable debate in political and policy circles. Supporters of the mergers believe that greater consolidation in the industry is essential for Canadian banks to remain competitive in an increasingly global economy. Opponents argue that greater consolidation will result in reduced competition among Canadian banks, higher prices for banking services, and reduced consumer welfare. The highly politicized nature of the debate concerning the merits and demerits of the mergers has precluded intelligent discussion of the issues (with the notable exception of the excellent analysis in Mathewson and Quigley 1998).

Concerns about the negative impacts of mergers are misplaced and reflect a fundamental misunderstanding of how technological progress is changing the nature of the financial services industry. As a result of improvements in computer systems, software, and communications networks, it is no longer necessary for banks to have a physical presence in all communities in order to deliver banking products. Large-scale rationalization of the physical infrastructure of the banking system is necessary if the banks are to adopt these new technologies--technologies that can reduce many of the transaction costs associated with banking. Merging is an effective way for the large chartered banks to effect this rationalization and do away with the excess ``bricks and mortar'' associated with the conventional delivery of banking services.

Opponents of the mergers fail to realize that the main barriers to competition in the financial services industry are not due to features of the industry per se. Rather, they are a product of government regulation that limits the ability of firms--in particular, foreign-owned financial institutions--to enter the Canadian market and compete on an equal footing with existing institutions. Indeed, if Canadian consumers are to realize the benefits associated with the rationalization of current banking infrastructure, it is imperative that the federal government remove existing barriers to competition. Hence, as part of an overall reform package, it is important that ownership restrictions on financial institutions be removed and that regulatory barriers to entry be repealed.

Our study is organized as follows. Part 1 provides an outline of the structure of the Canadian financial industry and briefly describes the nature of financial services regulation. Part 2 presents a brief overview of Canadian competition law and the impact that it may have on bank mergers. Part 3 discusses the issue of market power and shows that what matters for competition is not the number of firms in an industry but rather the threat of entry and technological progress. Part 4 presents empirical evidence showing the benefits of the current rationalization of the banking system and the extent of technological progress. Part 5 presents empirical evidence demonstrating the difficulty of defining markets in the financial services industry. Part 6 offers a number of policy recommendations for restructuring the banking sector.

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Last Modified: Wednesday, October 20, 1999.