Office of the Superintendent of Financial Institutions

Report to the Minister of Finance
on the Proposed Merger of Canadian Banking Institutions

Background Information

December 1998

1.	What is the Office of the Superintendent of Financial Institutions (OSFI)?
OSFI is the primary regulator of banks and other federal financial institutions and private pension plans. OSFI's main mandate is to safeguard policyholders, depositors and pension plan members from undue loss and to contribute to public confidence by promoting the safety and soundness of the Canadian financial system and intervening early when problems emerge.
More information on OSFI can be found in the section About OSFI.
2.	What was the role of OSFI in the decision of the Minister of Finance?
OSFI was asked by the Minister of Finance to:
i)	Determine whether, if the merger proposals were allowed, there was a significant likelihood that either merged bank would not have sufficient financial strength, or could be financially weaker than its predecessors; and
ii)	Consider whether, if the merger proposals were allowed, and one of the merged banks later suffered serious financial problems, the resolution of those problems would be more difficult than now.
These questions fit with OSFI's safety and soundness mandate. OSFI's report deals only with prudential issues and does not deal with competition or other public policy issues. It is one among a number of inputs that the Minister of Finance sought in reaching his conclusions on the proposed merger transactions.
In order to make findings in these two areas, OSFI was provided with confidential proprietary information by the banks that OSFI is required by law to maintain in strict confidence. However, so the public can better understand OSFI's findings in this unique situation, a Report was provided by the Superintendent to the Minister of Finance and is being made publicly available.
3.	What are the key findings from OSFI's Review?
OSFI’s review contained a number of findings based on an analysis of the merger proposals, research, and experience in other jurisdictions. These findings can be found in the Report to the Minister of Finance which accompanies this background material.
OSFI's key findings fall into three categories:
	Prudential
	OSFI did not identify prudential reasons which, in and of themselves, should prevent the proposed mergers from being considered by the government. OSFI did not identify issues which would be likely to have a material adverse impact on the financial viability of either merged bank. Similarly, OSFI did not identify other material concerns regarding the safety and soundness of the banks if the mergers were to proceed.
	System Issues
	The possibility of failures occurring is recognized in OSFI's mandate. In order to compete and prosper, financial institutions are allowed to take reasonable risks that can, in some circumstances, lead to financial problems. The risk of failure is not limited to institutions below or above certain sizes. The government has recognized that mechanisms, such as a strong supervisory and regulatory system, reduce but do not eliminate the possibility of financial problems or failure.
	So, OSFI considered whether resolving a problem would be made more difficult in the unlikely event that one of the merged banks were to develop financial problems. There are currently a number of mechanisms for dealing with financial institutions, both large and small, that experience financial problems. These mechanisms -- which include recapitalization, sale of individual business lines, and outright sale of the institution to a qualified buyer -- currently exist in the event that a major bank experienced financial problems. If the mergers were approved and one of the merged banks experienced serious problems, these options would probably still be available. However, some would be more complex and difficult, more time consuming, and possibly more costly to implement given the size of the merged institution in relation to potential buyers and investors.
	The relative importance of these issues to the overall merger decision is a matter that can only be fully assessed by the government, since some approaches to dealing with this issue may require tradeoffs with existing ownership and competition policies. For example, the purchase of all or part of a merged bank that experienced problems by other large financial institutions could raise competition concerns, while the purchase by a non-Canadian institution might not be acceptable under the government's ownership policy then in effect.
	Supervisory Issues
	The increased size and complexity of the merged banks would create supervisory challenges and may require new approaches. These issues do not affect OSFI's overall findings.
4.	What were the limitations of OSFI's review?
There is little prior experience with large mergers in the financial sector in Canada. In addition, OSFI focussed its review on the proposed transactions as currently described, rather than on the impact on the sector as a whole, and did not consider the impact of any potential modifications to these transactions.
In the circumstances, detailed integration planning had not reached an advanced stage within the banks. A review of detailed implementation plans would be required if a formal recommendation on either transaction was sought.
5.	What did the review consider?
Among the issues considered were: the soundness, from a prudential perspective, of strategic plans; the nature and quality of available implementation plans; the impacts on material projects currently underway in the banks; potential changes to the risk profiles of the banks; impacts on mechanisms for monitoring and controlling risks; ability of senior management and boards of directors to manage the increased complexity; and the reasonableness of financial projections. The review did not second guess the motivations put forward by the banks for wanting to merge. Similarly, the review did not consider matters such as employment impacts, service charges, and levels of customer service, as these fall outside OSFI's prudential mandate.