Munich Personal RePEc Archive
Can consumers bank on mergers?
Kerton, Robert / R
Institute for Research on Public Policy
2003
Online at https://mpra.ub.uni-muenchen.de/20545/
MPRA Paper No. 20545, posted 09 Feb 2010 09:13 UTC
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elen t less is t h e siren so n g fo r m ergers am o n g Can ad a’s b ig b an ks. Siren s, o f co u rse, were sea n ym p h s wh o san g so en ch an t in gly t h at sh ip s wo u ld crash o n t h e ro cks. In a b an kin g co n t ext , su ch m u sic can b e exp ect ed fro m t h o se wh o earn h u ge fees p u t - t in g m ergers t o get h er, an d fro m rep airin g t h em lat er.Q u est io n : Is t h e fait h in et ern al eco n o m ies o f scale ju st i- fied ? Is it a siren so n g o f in n o cen t self-d elu sio n ,—a b elief t h at h elp s o verco m e t h e d isco m fo rt arisin g fro m wan t in g a m erger fo r n o rm al reaso n s? It is im p o rt an t t o lo o k at im p art ial evid en ce o n t h e scale issu e, b u t first co n sid er t h e d egree o f scru t in y t h at is given t o m erger p ro p o sals fro m Can ad a’s largest b an ks.
A m erger am on g big ban ks faces th ree tests: for p ru d en - tial safety, for com p etition , an d for th e p u blic in terest. Th at seem s like a lot. Is it? Do we n eed fu rth er p rotection t h ro u gh a p o lit ically d riven p u b lic in t erest t est ? Last October, th e m in ister of fin an ce asked both th e Stan d in g Sen ate Com m ittee on Ban kin g an d Fin an ce an d th e Hou se of Com m on s Com m ittee on Fin an ce to assess th e m atter. By Decem ber, th e rep ort of th e Sen ate com m ittee was ou t, an d it d elivered a m essage th at is very clear in recom m en d in g th e rem oval of Can ad a’s p u blic in terest test for p rop osed m ergers am on g large ban ks. It recom m en d ed , “p arliam en - tary com m ittee review of sp ecific ban k m erger p rop osals n o lon ger be req u ired ….”
Evid en ce on m ergers in gen eral is a cau tion to th e son g of th e Siren s. Most m ergers d o n ot p ass th e m arket test. In an assessm en t of abou t 300 big m ergers, a recen t Business W eek an alysis sh ows th at 61 p ercen t of bu yers d estroyed sh areh old er wealth . Big ban k m ergers d id n ot ach ieve th e
$100 billion d estru ctive cap acity of th e AOL Tim e Warn er m erger, bu t Fleet Boston , Ban k On e, Nation sban k an d th e oth ers d estroyed 10 p ercen t of th eir valu e becau se, as Business W eekp u t it, th ey “en vision ed gran d syn ergies th at p roved illu sory or u n workable.”
Th e collap se of th e m erger m ovem en t, an d th e h u ge p ortion of m arket valu e d estroyed by th ose m ergers, sh ou ld h ave cau sed every an alyst to look m u ch m ore carefu lly at assertion s th at m ergers am on g gian ts will im p rove th e p ros- p erity an d com p etitiven ess of th e n ation al econ om y. Th e com p etitive race m ay go to th e swift—to th e agile—n ot to th e on e with th e m ost bu lk. W h en we m erge two gian ts, we p aste togeth er two d ifferen t n etworks of in form ation ; we o ft en ad d t wo co rp o rat e cu lt u res. Th is can resu lt in Tyran n osau ru s rex.
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h ere is a lot to be said for ban ks of th e cu rren t size in Can ad a, or for a few m ore p articip an ts. In d eed , th e Sen ate rep ort n oted th at barriers to en try n eed atten tion . Big ban ks n ow offer im p ressive tech n ological services an d th ey are am on g th e best of corp orate citizen s in d on atin g toOPTIONS POLITIQUES
M ARS 2003
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CAN CONSUM ERS BANK ON M ERGERS?
Robert R. Kerton
Canada's large banks are again enchanted by a siren song of mergers that could see the good ship of Canadian banking founder on the rocks, suggests economist Robert Kerton, dean of arts at University of Waterloo and an authority on banking and consumer issues. The big banks may have already captured many of the economies of scale they would purportedly gain from mergers, but would do well to improve their service if they really aspire to be world-competitive. He enumerates five issues, including concentration of power, which proposed mergers should have to deal with, in the public interest—reason enough to retain parliamentary oversight.
Les grandes banques canadiennes sont ravies de voir la question des fusions refaire surface m êm e si, à l'instar des m arins charm és par le chant des sirènes, cela risque de faire couler leur navire. Or, il est bien possible que les banques aient d'ores et déjà avoir réalisé la plupart des économ ies d'échelle qu'elles attendaient des fusions, m ais elles tardent toutefois à am éliorer les services à la clientèle. Elles devraient y songer sérieusem ent, si elles désirent vraim ent être com pétitives à l'échelle
m ondiale. Dans l'intérêt public, les fusions devraient être soum ises à cinq conditions - notam m ent le niveau de concentration du pouvoir - et cela exige que le
Parlem ent continue d'exercer son rôle de supervision.
co m m u n it ies an d in vest in g in t h e fu tu re of Can ad a. Do ban ks h ave th e com p etitive agility to com p ete abroad ? Evid en ce from p reviou s attem p ts is n ot reassu rin g: Un wise loan s to th e Can ary W h arf p roject in th e UK m ean t th at two of ou r largest ban ks wrote off losses of abou t $800 m illion p er year for five years.
In t h e last few years, m an y ban kers h ave been m o re d irect , an d m o re cred ible, in st at in g t h at t h e issu e is sim p ly t h e gro wt h o f t h e ban k, wh ich can be ach ieved m o st q u ickly t h ro u gh m ergers. Th e n at io n al in t er- est is n o t t h e m ain jo b o f ban kers. Th e q u est io n is: Wo u ld m ergers am o n g big ban ks m ake t h in gs bet t er, o r wo rse, fo r u s all?
H ist o rically, C an ad ian sen at o rs an d Can ad ian ban ks h ave always been close to each oth er—th e Sen ate really u n d erstan d s ban ks—an d recen t h ear- in gs attest to th at. Bu t, if th e good Sen ators h ave a carefu l u n d erstan d in g of wh at is good for ban ks, it d oes n ot n ecessarily follow th at th eir ad vice is always bad for th e rest of u s. Th eir m ain con clu sion was word ed in sever- al ways. Th e m ost in terestin g p h rasin g was, “We con clu d ed th at, on ce th e p ru d en tial an d com p etition con cern s were ad d ressed , a m erger wou ld be a n et p ositive for Can ad ian s.”
It raises t h e issu e o f wh et h er t wo o t h er t est s a re en o u gh t o lo o k aft er t h e p u b lic in t erest . Th e O ffice o f t h e Su p erin t en d en t o f Fin an cial In st it u t io n s (O SFI) ap p raises p ru d en - t ial m at t ers. Th e Co m p et it io n Bu reau ap p raises m arket issu es. Fact o rs t o b e co n sid ered b y t h e Bu reau an d t h e Trib u n al an d exp ressly referred t o in t h e Act in clu d e: t h e am o u n t o f fo r- eign co m p et it io n ; wh et h er a p art y t o t h e m erger h as failed o r is likely t o fail; availab ilit y o f su b st it u t e p ro d - u ct s; an y b arriers p reven t in g n ew co m p et it io n fro m en t erin g t h e m ar- ket ; t h e ext en t t o wh ich effect ive co m p et it io n rem ain s in t h e m arket ; t h e likelih o o d o f rem o val o f a vigo r- o u s an d effect ive co m p et it o r; an d t h e n at u re an d ex t en t o f ch an ge an d in n o vat io n in a relevan t m arket .
As n oted , sen ators felt th at th ese two assessm en ts were su fficien t. W h y m igh t co n su m ers agree o r d isagree th at two reviews are en ou gh ? Th ere are five issu es:
1. Concentration of power: Can ad ian s h ave lon g been con cern ed abou t th e con cen tration of p ower. Som e are an x- io u s ab o u t t h e excessive at t en t io n elected officials wou ld h ave to p ay to t h e n ew gian t s, a m at t er receivin g atten tion am on g cu rren t m em bers of Parliam en t in resp on se to th e p rim e m in ist er’s p ro p o sals o n cam p aign fin an cin g.
2. Sharing the m onopoly benefits: Ho w m u ch o f t h e “valu e” sh areh o ld ers a n t icip a t e fro m p ro p o sed m ergers rest s so lely o n co n ven t io n al m arket m o n o p o ly? Even if gain s exist ed , co n - su m ers an d sm all firm s n eed n o t see an y b en efit s fro m b igger b an ks. Prices relia b ly rise a s co m p et it io n is red u ced . So m e p ro p o n en t s, wh o feel cert ain t h at eco n o m ies o f scale exist , can n o t exp lain h o w t h e red u ced co m - p et it io n will in crease lo an s t o sm all b u sin ess, o r h o w it will resu lt in m o re at t en t ive service, o r lo wer b an k fees.
In fact , m u ch evid en ce exist s fro m st u d ies o n b an k m ergers elsewh ere, t o sh o w t h at , o ver a cert ain size level, eco n o m ies o f scale are eit h er ab sen t o r u n im p o rt an t .
3. Quality: Ban ks h ave n ot been lead ers in cu st o m er sat isfact io n . Rem em ber th at it was com p etition from an in d e- p en d en t tru st com p an y th at obliged ban ks to offer better h ou rs to cu s- tom ers. In work I su p ervised for th e MacKay Task Fo rce, several service ch aract erist ics w ere id en t ified an d service levels in eigh t cou n tries were assessed . Can ad ian ban ks d o well in som e com p etitive d im en sion s su ch as tech n ology an d less well in oth ers, in clu d in g d o cu m en t clarit y. Ro ger Martin , Dean of th e Rotm an Sch ool of M an agem en t at t h e Un iversit y o f To ro n t o , u n d o u b t ed ly h as it righ t wh en h e observes th at to su cceed in in tern ation al m arkets, a firm can n ot be a com fortable oligop olist at h om e.
Dem an d in g co n su m ers h elp a firm ach ieve excellen ce th rou gh im p rove-
m en ts in q u ality. Th ere is n o evid en ce th at th e u se of h igh er reven u es from m on op olizin g m arkets at h om e will lead ban ks to su ccess in d eliverin g in t ern at io n al levels o f service. Th e con trary is m u ch m ore likely.
How d o Can ad ian fin an cial in sti- tu tion s d o in in tern ation al m arkets?
Th e evid en ce on exp orts is clear: Th e big su ccesses h ave n ot been ban kin g or t h eir in vest m en t h o u ses, b o t h o f wh ich h ave been retreatin g from a low level of in tern ation al sales. Th e win - n ers are C an ad ian -b ased in su ran ce com p an ies. In 2001, Can ad ian life an d h ealth in su rers earn ed $50.2 billion , or 56 p ercen t of th eir p rem iu m s from for- eign sou rces.
A su rvey of service sector p erform - an ce con d u cted by Can ad a’s Nation al Q u ality In stitu te fou n d ban ks 16th fro m t h e t o p o u t o f 2 0 service p rovid ers in 1996. In 1997, ban ks were 1 7 t h o u t o f 2 1 . M o re im p o rt an t , evid en ce in d icat es t h at t h e m o re m on op olized an in d u stry is, th e lower
POLICY OPTIONS
M ARCH 2003
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Can consum ers bank on m ergers?
Tower above: The Royal Bank Building at Place Ville M arie in M ontreal.
Th e Gazette, Mon treal
it scores wh en cu stom ers assess service q u ality. Su p erior cu stom er satisfaction is th e m ost p rom isin g, th e m ost reli- able, an d p robably th e only p ath to lon g-ru n su ccess.
4. Innovation:Do in vestm en ts in in for- m at io n t ech n o lo gy ex h ib it st ro n g econ om ies of scale? For item s th at are stan d ard ized , th is is very often tru e.
W h ere services h ave su btle d istin c- t io n s t h at m at t er, scale eco n o m ies h ave been h ard to fin d . Th ere is a h u ge d ifferen ce between (a) loan s, wh ich n eed sp ecial in fo rm at io n , an d (b ) ban kin g m ach in es, wh ich d istribu te
stan d ard cash th rou gh ATMs. For con - su m ers, ATMs save t im e (wh ich is im p ortan t), bu t in form ation tech n olo- gy also facilitates n ew an d im agin ative form s of p rice d iscrim in ation .
Th e ATM fees are a go o d exam p le.
It is a bit like Mark Twain ’s claim fo r t h e virt u e o f fish in g at Niagara Falls:
Yo u d o n ’t h ave t o go so far t o not cat ch a fish . Wit h ATMs yo u d o n ’t h ave t o go so far t o get st u n g by an in n o vat ive fee. In fo rm at io n t ech n o lo - gy, esp ecially wh en u sed wit h d at a m in in g, allo ws a co m p let ely n ew level o f p rice d iscrim in at io n . Un less we d evelo p a co u n t erst rat egy, t h e in n o va- t io n m erely sh ift s p o wer fro m co n - su m ers t o sellers.
Man y in n ovation s are in d ep en d - en t of th e m erger issu e. However, it is by n o m ean s certain th at m ergers th at red u ce com p etition can h ave an yth in g bu t a n egative effect on in n ovation . After all, in n ovation is on e com p on en t of com p etition .
5. Too big to fail:W h en ever bu sin esses reach th e “Too Big To Fail” level, risks are rem oved from in vestors an d p laced on taxp ayers. Th ere is little com fort in th e retort th at big Can ad ian ban ks are
alread y too big to fail. Still, it is sober- in g t o co n t em p lat e t h e lo sses Can ad ian ban ks m igh t h ave m ad e in th e US telecom an d tech sectors if th e 1998 p rop osals for blockbu ster m ergers h ad been ap p roved .
Th e growth of ban ks relies fu n d a- m en tally on th e ability to offer n ew an d com p etitive services at a world level of excellen ce. To exp an d abroad , a p lau sible case exists for sh arin g m an - agerial exp ertise th rou gh p artn ersh ip s with firm s abroad .
To reso lve t h e issu e o f scale econ om ies it is worth wh ile to listen to
th e social p h ilosop h er, Yogi Berra, wh o fam ou sly said : “You can see a lot, ju st by lookin g.”
W
e can look at th e resu lts of all t h e st u d ies o f eco n o m ies o f scale. Virt u ally all evid en ce o n econ om ies of scale agrees th at ban ks alread y at th e size of Can ad a’s big five h ave cap tu red available scale efficien - cies; fu rth er in creases in size offer little or n o ad d ition al gain s. Th ere is a sin gle stu d y, recen tly in th e Canadian Journal of Econom ics, th at su ggests th ere are u n ex p lo it ed scale eco n o m ies—co n - trary to all th e oth er evid en ce. Th e research is im p ressive on m an y p oin ts bu t th e m ain resu lt relies en tirely on t h e assu m p t io n t h at t h ere is on e national m arket wh ile m ost con su m ers an d firm s op erate in a localm arket th at will h ave fewer com p etitors after a big m erger. Th is cru cial p oin t, local or n at io n al m arket , h as alread y b een research ed for firm s m akin g loan s, an d wh at m atters is, in d eed , th e local m ar- ket . Th e lat t er research fin d s t h at , wh en oth er factors are allowed for, bran ch closin gs in Can ad a are associat- ed with h igh er in terest on loan s tosm all bu sin esses. Th is is a robu st resu lt.
It m ean s th at fu rth er m ergers am on g big ban ks will m ake all sm all Can ad ian firm s less com p etitive at h om e an d abroad .
Th ere is every reaso n fo r Can ad ian s t o wan t t o see o u r ban ks su cceed ab ro ad . Su ccess, h o w ever, m u st be earn ed in a way t h at “h elp s t o im p ro ve t h e p ro sp erit y an d co m p et i- t iven ess o f t h e n at io n al eco n o m y,” t o q u o t e fro m t h e Sen at e rep o rt . Ban k m ergers m ay n o t h arm C an ad a’s biggest bo rro wers becau se t h ey h ave access t o co m p et it ive in t ern at io n al fin an cial m arket s. Man y o f t h e largest co rp o rat io n s h ave d ep lo yed “d isin t erm ed ia- t io n ” by skip p in g Can ad ian ban ks an d go in g d irect ly t o bo n d m arket s t o raise fu n d s.
Th e o p t io n is n o t available t o lo w-in co m e Can ad ian s.
However, som e ru les for basic ban kin g h ave been created with - ou t an y d irect tie to th e m erger d iscu s- sion s. All th at recogn ized , th e best available evid en ce in d icates th at m erg- ers am o n g large b an ks w ill h arm Can ad ian con su m ers an d sm all an d m ed iu m firm s, in clu d in g p o t en t ial exp orters. It th erefore seem s im p ossi- b le t o m eet t h e Sen at e Ban kin g C o m m it t ee’s req u irem en t t h at b ig ban k m ergers m u st “im p rove th e p ros- p erit y an d co m p et it iven ess o f t h e n ation al econ om y.”
In su m , th ere are factors im p or- tan t to th e p u blic in terest th at are beyon d p ru d en tial m atters ad d ressed by OSFI, an d beyon d th ose m arket issu es looked at by th e Com p etition Bu reau . Th u s, th ere is still a n eed for p arliam en tary oversigh t of m erger p ro- p osals to en su re a ben efit to Can ad a.
Robert Kerton is a professor of econom ics and Dean of the Faculty of Arts at University of W aterloo. He serves as chair of the Econom ics and Finance Com m ittee of the Consum ers Association of Canada, and appeared before both the Senate and House of Com m ons com m ittee hearings on large bank m ergers and the public interest.
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Robert R. Kerton
