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October 24, 2002 Bank mergers are beneficial: economist McIntosh to Senate



Economics professor James McIntosh

Photo by Andrew Dobrowolskyj

by Sylvain Comeau

James McIntosh doesn’t waste any time cursing bank fees or service. He’s too busy examining the issue of bank mergers, and he has found that they would be good for this country, not just for the banks.

At the end of November, the Concordia professor of economics made a presentation to the Senate Banking Trade and Commerce Commission, a Senate committee that held hearings on bank mergers. McIntosh presented a paper he had written that was published in the Canadian Journal of Economics in which he concluded that the government should give banks the green light.

“Bank mergers are in the public interest, for two main reasons. First, Canadian banks are characterized by increasing economies of scale; that means that the bigger the bank, the lower its unit costs. It’s like WalMart; they are a cheaper store than the Bay because they are a lot bigger; they can save money by doing discount buying and economizing on expenses. The same is true with bigger banks; they will be able to lower their fees, and it will be in their interest to do so, because they want to sell more banking services.”

One popular objection to bank mergers is that reduced competition will lead to higher fees, but McIntosh contends that economies of scale will be the dominant factor. That was the conclusion of computer models he ran to simulate the results of mergers in an oligopoly situation (a market controlled by a small group of competitors).

He also argues that mergers would increase profits at the banks, which is good for Canadians, many of whom own shares in the big six chartered banks.

“Bank profits are distributed to individuals, people with pension funds or mutual funds — those are the people who own the banks. John Q. Public benefits from bank profits, not just bank executives. In addition, banks make a huge contribution to Revenue Canada, in the form of 37 per cent of their profits paid in taxes. The Royal Bank made $2.75 billion this year, which means about $900 million paid in taxes. If we need $5 billion to improve the health care system, banks will provide a very large chunk of that.”

Aside from the domestic market, the banks have often cited competition from giant international competitors as a reason for merging; in other words, they need to get bigger at home before taking on the big boys on the world stage. McIntosh wonders why we would not want them to do so.

“Canadian banks are afraid of competitors like [Holland bank] ING Direct or [American bank] Wells Fargo, who offer virtual banks; today, you can get a mortgage or a loan approved online. Wells Fargo can do that because they are big; they have a huge financial base. The Canadian banks say, ‘If we could get big like Fargo, we could do it too,’ and the government is saying, ‘No, you can’t.’ Right now, they can’t afford to take the risk, because it costs $500 million to set up a virtual bank.”

While Canada’s banks may appear monolithic to the average Canadian, McIntosh points out that our biggest financial institutions barely crack the top 50 of the world’s biggest.

“They are really small compared to international banks. They want to be the merchant bankers for Canadian corporations, but at the moment, Canadian corporations like Bombardier, Alcan and GM of Canada use big American banks for their IPOs, mergers and acquisitions. The reason is that Canadian banks are just not big enough.”

In addition, McIntosh points out that financial services could become a major Canadian export. He cites the insurance sector as a dynamic model for that.

“If you look at the insurance business, companies like Manulife Financial and Canada Life, they do more business outside of Canada than inside. And this is good; it means we’re exporting financial services, and the head office jobs are here in Canada.

“A country has to export something, and it’s better to export high quality, high value added commodities that employ skilled people, rather than things like paper or manufactured goods. We couldn’t compete in a lot of categories of manufactured goods because they are usually made in countries with lower labour costs. We want to be more like the Swiss and the Dutch, who specialize in products that have high human capital requirements.”

Despite all these reasons for mergers, McIntosh acknowledges that the banks may well be turned down again because of continued sour public sentiment.

“This is hard to sell politically, because everybody hates banks. That’s just a fact, and then when you tell them the banks are going to get even bigger … they don’t react too well.”

McIntosh’s paper on bank mergers was funded by the Royal Bank and Bank of Montreal, but he emphasizes that he is an academic who came to similar conclusions in previous, unfunded papers he wrote about the possibility of mergers among insurance companies.