Following Canada's Example

America's banks promise to get a lot bigger. Citicorp and Traveler's, BancOne and First Chicago and Bank America and Nationsbank all announced their engagements over the past two weeks in deals totaling $174 billion--almost equaling the $200 billion in financial services mergers announced worldwide during all of 1997.

At one level, these mergers just feel right. The nation seems to take great pride in having the world's largest software company (Microsoft), largest computer company (IBM), largest car company (GM), largest oil company (Exxon) and so on. With these mergers, America could well have the world's largest financial institution again. And that's as it should be.

At another level, consumer advocates claim to be terrified that as the banking industry consolidates, choice will be curtailed and prices will rise as financial behemoths exploit their new-found market power.

But there is an opposing view: that consolidation in the banking industry is going to be nothing but good for consumers. There are important theoretical reasons why, but to begin, let's consider the experiences of consumers in a country with the most concentrated banking industry in the industrialized world: Canada.

Canada is a good comparison for a number of reasons. First, it's culturally the most similar to the U.S. of any country in the world. This is important when talking about something as personal as money and people's relationships with it.

Second, Canada stands at the opposite end of the spectrum from the U.S. with respect to the structure of its banking industry: in 1995, the five largest U.S. banks controlled 9.7 percent of U.S. domestic assets. In contrast, the five largest Canadian banks controlled 58.1 percent of Canadian domestic assets. Furthermore, Canada's banking is also less regulated: many of the regulatory constraints being challenged by recent U.S. mergers were removed almost ten years ago in Canada--everything from permitting banks to enter stock brokering to selling insurance.

If big banks really do pose a threat to the public, then Canadian consumers should have long ago begun chaffing under the weight of this market structure. But they haven't. The reason is simple: the Canadian banking system is just better than that of the U.S. For example, service charges are lower in Canada than in the U.S. As a result, Canadian banks are forced to rely much more heavily on net interest income as a source of profits.

Net interest income is a function of the interest spread--the difference between the rates charged to borrowers and the rate paid to depositors. Given that Canadian banks are reasonably profitable, ranking just behind the U.S., you'd think that this means that the spread is much higher in Canada. It's not. Historically it has been consistently lower, and over the last five years, it has been fully one-third lower than in the U.S.

Then, with acceptable profits, lower service charges and lower interest spreads, those Canucks must be suffering with some pretty miserable service, eh? Wrong again. Canada has the highest number of branches of all G-7 nations and the second largest number of automated banking machines.

Furthermore, many "invisible" elements of the banking system function much more efficiently in Canada than in the U.S. The payments systems, that labyrinthine set of collection depots, clearing houses and funds transfer networks that enable such mundane financial instruments as personal checks and automatic payroll deposit tend to run much more smoothly. For example, a check written by a New Yorker for a purchase in a store in Los Angeles store with its accounts in a Californian bank can take up to four days to clear. In contrast, a check written in Vancouver on a bank account in Halifax can clear the same business day.

In addition, Canadian banks are among the most innovative in the world. Debit and stored value cards were pioneered in Canada, while both are still just catching on in the U.S. Also, Internet banking is more advanced in Canada, with a higher percentage of bank customers using computer-based distribution channels, despite lower PC penetration.

The reason for this higher level of consumer welfare is deceptively simple: there's no such thing as a banking industry anymore. There is only a financial services industry. And while the Canadian banking sector is highly concentrated, its financial services sector is not. Fifty trust companies, many with near-national reach, offer a range of services comparable to that of the banks; 2,500 credit unions and caisses populaires (Quebec credit unions) remain important retail outlets; 150 life insurance companies offer a wide range of investment vehicles; 80 mutual fund companies command 77 percent of the Canadian mutual fund market. Canadian banks, due to their size and scope, constitute five more competitors in each of these markets, not leviathans standing astride any one of them.

In the United States, every aspect of the financial services is dominated not by a bank but by a focused, non-bank with national scale. For example, MBNA is the largest issuer of credits cards. Fidelity, a mutual fund company, and Charles Schwab, a stock brokerage, dominate investment instruments. CountryWide commands the lion's share of the consumer mortgage market.

When American banks attempt to reach national scale in these same lines of business, their explicit intent is to be able to compete with these "monoline" companies. The banks aren't seeking gargantuan size in order to strangle any one market, but simply to keep up in all of them. The battle to be waged in the marketplace is whether consumers prefer one-stop shopping, or picking and choosing among "best of breed." That is a choice consumers should be allowed to make. To the extent that banks succeed in entering a wide range of markets, financial services will become more competitive, not less.

Finally, remember that competition is a market-specific issue: you can only choose from the service providers that compete in your market. Consequently, the fact that Illinois has 1,000 banks doesn't mean that Chicagoans have 100 times the choice of Torontonians. Six or eight national banks in the U.S. probably means six or eight banks in every community--which in many cases is probably more than at present, not fewer.

The bottom line? These mergers are good, and for all the reasons you'd never expect: they will increase competition, customer choice, product and service innovation and lower prices.

Michael E. Raynor '90 is a doctoral candidate at the Harvard Business School. His dissertation research is on the entry of the four largest Canadian banks into the securities industry.