EVIDENCE

[Recorded by Electronic Apparatus]

Thursday, June 15, 1995

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[English]

The Chair: The finance committee is beginning its first investigation into Canada's financial institutions. The basis for our inquiry is the white paper presented in February by the Hon. Doug Peters.

We were anticipating that we would have legislation flowing from that paper by today. We understand we will not have that, but it's possible this legislation will be tabled in the House of Commons before the end of this sitting. We understand there will not be major changes from the white paper in the legislation.

We look forward to our presentation today from the Department of Finance: Mr. Nick Le Pan, Special Adviser to the Deputy Minister; Mr. J.R. La Brosse, Director of Financial Institutions Division; and Ms Patty Avenoff, Senior Economist.

As I mentioned, this is the first look we have had as a committee at any financial institution structure or legislation. In a brief discussion I had with Mr. Le Pan before this meeting, he thought he might just start off very briefly to take us back to the structure that existed in prior years, which is the four pillars. Then he will bring us up to the present and take us through the white paper and the possible legislation.

We look forward to your presentation and thank you very much for being with us.

Mr. Nick Le Pan (Special Adviser to the Deputy Minister, Department of Finance): Thank you, Mr. Chair. I very much enjoy being here.

I would like to talk a bit about the history of the four pillars and how we got to where we are at the moment. Then we have a short piece of paper that we would walk members of the committee through for information. We'll stop as necessary or take questions at the end relative to the kind of white-paper proposals and what will be in the legislation.

If I go back in history to pre-1987, fundamentally, the Canadian financial system was thought of as having four pillars: chartered banks, which were federally regulated; the trust and loan companies, of which some were federally incorporated and regulated, while some were provincially regulated; the insurance industry, which is composed of various parts, such as life insurance and property and casualty, and which is in part federally regulated and in part provincially regulated; and the securities dealers, which are essentially provincially regulated.

In 1987, in response to market pressures and a number of moves by regulators, particularly in the provinces of Quebec and Ontario, the possibility of foreign institutions and banks, and then domestic banks, to own securities dealers was provided for. Subsequent to 1987, we saw many of the securities dealers become acquired by banks, either domestic or foreign. Some securities dealers have been acquired by non-bank financial institutions, but the major ones went with the banks.

That, of course, was partly due to, as I said, some of the market pressures whereby Canadian dealers were seen to be relatively less capitalized compared with their foreign competitors. And, of course, there was a movement in financial markets away from direct intermediation of savings through a financial institution to an ultimate borrower and more of capital being raised directly in capital markets by users of capital: small, medium-sized, and large corporations. Therefore, more of the capital-raising and capital-using process is happening through markets and through securities dealers' involvement in markets, and is less directly involved in intermediation through banks, trust companies, and others.

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At the same time, in the 1980s the issue of ownership of financial institutions was very prominent. It arose partly because of very specific transactions, such as Genstar's acquisition of Canada Permanent.

It also arose because the governments of the day were looking at the appropriate ownership structure for federally regulated financial institutions. Should federally regulated financial institutions be widely held? Should they be permitted to be closely held?

At that time, and to this day, the main schedule I chartered banks were required to be widely held, whereas the possibility of close ownership existed in the trust and insurance sector and was quite prevalent. Though until the mid-1980s, the trust companies had been relatively widely held in any event. There have not been very many large, closely held trust companies.

The ownership debate was a very contentious one and was one of the main issues in the consideration of the revision of the financial regulatory statutes that went on, sometimes faster, sometimes slower, during the 1980s.

In 1992 that culminated in fundamental revisions to the federal financial institution regulatory statutes: the Bank Act, the Insurance Companies Act, the Trust and Loan Companies Act, and the Cooperative Credit Associations Act, because the federal government regulates some of the credit union centrals.

The changes that occurred in 1992 dealt fundamentally with four major blocks of issues. The first one was a further limited breakdown of the four pillars. In 1987 the securities dealer deposit-taking breakdown had occurred. In 1992 it became possible for deposit-taking institutions to own insurance companies. It also became possible for insurance companies to own deposit-taking institutions, including banks, if the insurance companies were widely held.

Since 1992 we have seen more movement towards actually breaking down the pillars de facto. However, that further breakdown in 1992 was only a limited breakdown of the pillars. It was not fully possible for banks or major trust companies to network insurance products in their branch networks, nor was it fully possible for them to use target marketing techniques to market insurance products directly to consumers. So there were limitations on the amount of breakdown of the pillars that occurred in 1992.

There were some areas of insurance in which it was possible for there to be fairly complete networking, such as travel insurance. And of course the major deposit-taking institutions have been in the insurance business for a long time, with credit-related life insurance on mortgages and credit cards.

The breakdown of the pillars was further limited because the insurance companies, for example, were not legally allowed to take deposits. The insurance companies do have developed products - term annuities - which are very similar to deposits in market terms, but they are not legally deposits. They are not covered by the Canada Deposit Insurance Corporation, and they have a different priority ranking should an insurance company be closed.

They have a number of different features. They also are not like deposits in the sense that they are not directly transferable by cheque. You cannot go and write a cheque on a term annuity. It looks very much like a term deposit, but there's no real analogy to a demand deposit in an insurance company.

So there was a breakdown of the pillars largely through the possibility of various groups of companies owning subsidiaries in other parts of the sector.

The Chair: Could you explain to us what a term annuity looks like?

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Mr. Le Pan: A term annuity could be structured in a variety of ways. When some of my ancestors were buying annuities, they made a bunch of payments, maybe even only one payment, and then got a whole bunch of payments back over a period of time, potentially over their lifetime. That's a simple annuity kind of product.

A term annuity would be as simple as making one payment to buy an annuity that gives five pay-backs. That is essentially a five-year term annuity, over the next five years. It is equivalent to a five-year guaranteed investment certificate issued by a trust company or a five-year term deposit issued by a bank, but it's legally an annuity product.

The Chair: It has no protection from CDIC?

Mr. Le Pan: No, it does not. It is protected by Comcorp, which I'll come to later in my presentation.

Other kinds of term annuity products could be structured over longer terms. It's any combination of how many premiums you pay and how many annuity payments you get back.

The second area the 1992 changes dealt with was the whole ownership issue. Fundamentally, the policy adopted by the federal government in the 1992 changes was to permit mixed forms of ownership for trust and insurance companies. Closely held ownership was to be permitted for trust and insurance companies.

The federal government maintained the 10% widely held ownership role for banks so that no one individual or group of related individuals could own more than 10% of a chartered bank. That was done for a variety of reasons, including prudential reasons. In fact, it is the norm in developed countries that, either de facto or by law, there is not the possibility of close ownership in the banking sector.

The third area of the 1992 changes was a series of enhancements to prudential rules to add requirements on companies related to their solvency or related to their dealings with their parent institutions. For example, in 1992 a number of changes were introduced to prohibit so-called self-dealing between a financial institution and its parent institution. Prior to 1992, in the trust and insurance area, the self-dealing rules had been rather less.

There are other areas in which the superintendent was given more powers or where limitations were placed on institutions. The prudential rules also included enhancements to corporate governance requirements. Many people on this committee will have heard of the recent Dey committee report for the Ontario Securities Commission that looked at corporate governance. One of the big issues in that committee report was a requirement for there to be independent directors on the boards of public companies.

The 1992 changes to the financial institution legislation require already that one-third of the board of directors be unaffiliated with the institution - not be a major borrower, not have a company that has a major consulting contract with the institution, and so forth.

In 1992 there were a variety of changes like that in the corporate governance area, such as requirements for independent members on audit committees and so forth.

The fourth area of the 1992 changes was essentially modernization of statutes. The Insurance Companies Act had not been amended in any significant way since I think about 1926; similarly for the Trust and Loan Companies Act. Meanwhile a lot of things in corporate law had moved on and improved. I recollect a simple example; under those statutes it was not possible to hold a meeting by telephone. There were a variety of modernizations to these statutes.

Also, particularly in the insurance companies area, there was some further definition of policyholder rights. As members may know, participating policyholders in an insurance company have some right to a return in addition to simply a loan or a pay-out of their policy should they die. They have some right to dividends out of the profits of the company.

Participating policyholders therefore are somewhat like shareholders, but they're also somewhat like policyholders. They're not quite the same as shareholders. The 1992 legislation looked at and provided them with certain rights to information that shareholders would normally have.

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Broadly speaking, to summarize 1992, the main goals were to provide some increase in competition through the further breakdown of the pillars; to enhance the self-governance and also the provincial supervision of these institutions; and to provide some modernization of the legislation so that it kept up with the times, was flexible, and didn't stand in the way of good corporate practice.

The 1992 legislation did not fundamentally deal with certain aspects related to safety and soundness, particularly the aspects related to closures of institutions - failures. By 1992 there had not been very many failures. The earlier failures had been in the early 1980s for federal institutions, with the two western banks, the Canadian Commercial Bank and the Northland Bank. By the time the major changes were made in the 1992 revisions, perhaps one or two trust companies were on the ropes, so to speak, but we had not seen the spate of failures in institutions that has occurred more recently.

That then brings us to the proposals in the white paper. The white paper proposals are broadly addressed to looking at some of the lessons learned from reviews by parliamentary committees - including the House finance committee in the previous Parliament and the Senate committee - of the situation arising from some of the major problem institutions as well as issues arising from the policyholder protection plan and the deposit insurance system.

Before I get into the white paper itself, are there other areas you would like me to cover in terms of history or discussion?

The Chair: You've been very clear. There are no questions. Go ahead.

Mr. Le Pan: You have before you a piece of paper, and I thought we might just flip the pages slowly to talk about the white paper proposals and where they came from.

A voice: They came from the Reform Party.

Some hon. members: Oh, oh.

A voice: Last night was a long night.

The Chair: These young people consider that midnight is quite late.

Mr. Fewchuk (Selkirk - Red River): It's what we did after midnight that needed energy.

The Chair: What the hell did you do after midnight, Fewchuk?

Some hon. members: Oh, oh.

The Chair: Come on! Everybody get awake. Let's go.

Mr. Le Pan: The purpose of these proposals is to further protect the interests of Canadians and, as I mentioned, to respond to past failures and ensure the system remains safe, sound, and efficient.

That fourth bullet is particularly relevant in relation to proposals in the white paper for clearing and settlement systems. More recently, since the mid-1980s, there has been a lot more focus internationally on ensuring that the clearing and settlement systems - the systems that link institutions and link markets - have adequate oversight and are safe and sound as well as efficient in an electronic sense.

Where did the pressure for legislative change come from? Obviously they need to maintain public confidence. I mentioned the problem companies. The more significant ones at the federal level are Central Guaranty Trust and Confederation Life.

The CDIC deficit is an issue that has been driving this package. CDIC has a significant deficit arising from either failures or its participation in assisting mergers of problem trust companies and to some extent a couple of banks, though the trust companies were the major contributors to this.

The Chair: What's the current deficit of CDIC, approximately?

Mr. Le Pan: As I recollect, the amount of debt outstanding from CDIC, which represents the total of their borrowings, is about $3 billion. It fluctuates down as they resolve the cases.

At the end of last year their total accumulated debt was about $1.7 billion. It has risen since that time; they've added about $0.5 billion to it. Their actual deficit was $590 million for last year. Their total debt is higher now, due to a couple of situations they've had to resolve since that annual report.

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The Chair: Is that treated as a loan from the federal government to the CDIC?

Mr. Le Pan: It is a loan from the Consolidated Revenue Fund to CDIC, yes.

The Chair: Is CDIC expected to operate on a break-even basis or what?

Mr. Le Pan: The short answer is no, because inherently CDIC is in the business of paying out claims to depositors and then recovering from the estates of failed companies by liquidating assets. CDIC is expected to eliminate its deficit, but I don't think it would be reasonable to expect it to run at zero forever.

I believe CDIC's target is to get to zero in about four to five years' time. It is possible that CDIC could then go on to levy premiums to build up a fund to deal with future possible failures.

The Chair: It has no income stream right now except realizing on assets of bankrupt or failed companies.

Mr. Le Pan: Its income stream comes from annual premiums -

The Chair: Paid by?

Mr. Le Pan: Paid by the banks and other participating member institutions, which are fundamentally the banks and the trust companies, and by realizations on assets of failed institutions.

Mrs. Brushett (Cumberland - Colchester): Is the annual premium in direct proportion to deposits?

Mr. Le Pan: Yes. The annual premium is a percentage of insured deposits, which means deposits up to $60,000. The premium right now is one-sixth of 1%, so that's about 16 basis points.

Mrs. Brushett: So then we can increase the premium?

Mr. Le Pan: The statutory maximum is set in the CDIC Act and legislation, and CDIC is now at the maximum. The legislation that will follow from this white paper provides for the possibility of an increased premium above the one-sixth.

That will be something for deliberation by Parliament. It could be used to pay off the deficit faster - to get premiums from member institutions more quickly.

The premium rate has been raised. By the end of the 1980s, it was at about one-tenth of 1%, so it's gone up by something like 60% in the past three or four years.

Parliamentary committee reports, as I've mentioned, examine some of the problem companies. There are seven or eight elements of the proposals in the legislative package. This page summarizes them, and I'm going to go through each of them in a little bit more detail in the pages that follow.

The first part of the package is a series of proposals related to earlier intervention and resolution of problem financial institutions. That includes some changes in policies, but it also includes recommendations for changes in legislation to permit earlier intervention in a variety of ways.

Related to that, but also for accountability, it is proposed that there be a specific statutory mandate for the Office of the Superintendent of Financial Institutions. They do not have a specific mandate now. I'll come back to that in a moment.

Some changes to facilitate earlier closure would include: more disclosure required of financial institutions about their financial condition; some changes to the deposit insurance regime, though those are not major; oversight of clearing and settlement systems for systemic risk; technical amendments; and the Policyholder Protection Board.

The Chair: What is a systemic risk?

Mr. Le Pan: A systemic risk is the risk that the failure of one institution will have a domino effect through a clearing and settlement system or through the relationships that institution has with other institutions and will cause failures of other institutions.

The Chair: Could you give us an example of how that might occur at present?

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Mr. Le Pan: Currently, all the major deposit-taking institutions are linked in what I've called the clearing and settlement systems, in that on any given day there are very large amounts of money that move between institutions to settle the transactions that have occurred in the economy in that day. We are talking about trillions of dollars here.

At any one time, there are vast amounts outstanding within a day between major institutions to represent all the business and personal transactions that have occurred.

Similarly, internationally, there are relations between Canadian banks and foreign banks because of the clearing and settlement of transactions in the foreign exchange market, which represents the financial side of all the international flows that have gone on during the day.

A third kind of system, Mr. Chair, relates to government debt. The government issues treasury bills and bonds regularly. There are flows back and forth between the financial system and securities issuers.

Take the initial example I used. The flows go back and forth to clear all the transactions between people who have written cheques and people who have received cheques, and so forth, during the course of the day.

Say at 1:37 p.m. an institution is closed. I use a time because there will be a specific time in law at which, if a major institution was closed, it will be closed. It may be a little fuzzy, but ultimately there will be transactions that will either get stopped or won't get stopped before or after a particular time. Normally, one would try to do this overnight, but there is a time at which an institution effectively becomes closed.

It is desirable for there not to be large amounts of transactions in the system stopped or reversed. If they were stopped or reversed, there is somebody else out there at another institution who's waiting for the other side of the payment.

A lot of these payments are not legally final until the day after. So I've given you money in exchange for something back, but it's not a transaction that's legally final until tomorrow. So now I'm closed.

What happens? You're out there trying to get the value that you thought you were going to get for which you've already given me. I'm going to hold on to what you've given me. It's not going to be me personally, but the liquidator of this institution who's going to hold on. That liquidator is in the business of trying to maintain the most value for the depositors of my institution.

What we have now is the potential for a knock-on effect because you have amounts outstanding that I haven't paid you for yet. They're big amounts because they are big flows.

There are developments going on in the financial community to, for example, reduce the amount of time between when I give something to you and you give something to me - reduce that amount of time to, for example, provide for a same-day settlement.

Right now, you have to wait until the next morning to get value. The proposals for a so-called large-value transfer system would allow these amounts to be cleared and settled between our two institutions on the same day and be legally final.

So as long as I wasn't closed in the middle of the afternoon - I was only closed after the time the settlement was legally final - we've reduced the possibility of a knock-on effect such that my failure will lead to a big hole in your balance sheet because there's an amount I owe you that I haven't paid yet.

There's a lot of development in the private sector of those systems to make those clearing transactions more efficient, safer, and faster so that there are no big holes if an institution had to be closed. Of course, the institutions that may be closed may be not Canadian institutions, but institutions in other jurisdictions that have clearing and settlement relations with Canadian institutions because of the foreign exchange market or whatever.

So these systems are being enhanced. Obviously we're talking about systems that have a fairly high level of technical, computer content to them because they're processing a large number of transactions. They have to do that rapidly because one tries to narrow the time between when I pay you something and you get value in return. We're trying to lessen that amount of time.

Then there's the issue of how to make sure that these systems are properly risk-proofed. In order to make sure there is not a risk of these knock-on effects, the system itself that is clearing these transactions and settling them has to be sound, have some oversight, have some capital, have some rules, and it has to sort out how any losses are shared, if there are any. Let me stop there.

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Mr. Campbell (St. Paul's): Mr. Chair, I was going to ask a question about the payment-for-settlement system, but subsequent to indicating that I had a question, I noted that Mr. Le Pan and the other presenters who are going through this are still at the introduction to the various things he wants to talk about.

Would you prefer that I held my question on the payment system until they actually got to that page and elaborated further on it?

The Chair: Is it a good question or just a fair one?

Mr. Campbell: Of course it is. I think, in the interests of getting through the material, maybe we should hold our questions until they've gone through each of the components, or do you think it's better if we ask as we get to each component?

The Chair: My feeling is that if later on Mr. Le Pan is going to be coming to a question you are asking now, he could indicate. Otherwise, since this is our first exposure, my gut reaction is that we should take as much time as we need and if we need a further meeting, I'm sure that Mr. Le Pan and company would be pleased to come back.

Mr. Le Pan: There is no question about that.

The Chair: We're going to be into this in a very big way for a long time, so let's get the basis solid.

Mr. Campbell: Very quickly on the Canadian Payments Association, it is not currently run by nor actively supervised by the federal government; it is run by the institutions themselves, pursuant to statute. Is that correct?

Mr. Le Pan: Pursuant to statute, the chairmanship is held by an officer of the Bank of Canada as the other link, but the government is as heavily into the financial institutions themselves. They make up all the membership of the board.

Mr. Campbell: Would your proposal be to create more oversight of that system?

Mr. Le Pan: Yes. I think the Canadian Payments Association fundamentally has deals with two types of payments. The payments that I've been talking about a few minutes ago I've sort of styled as wholesale payments. They're between institutions for large amounts.

The payment system also involves what I might call retail payments...you going to a banking machine, and what then happens to that and the arrangements by which, for example, bills get paid across the system. Those are the kinds of things I mean.

The stuff that's in the white paper in the proposed legislation is fundamentally dealing with safety and soundness issues in the wholesale part of the system. My ABM transaction is not going to cause systemic risk. The CPA deals with more retail issues as well.

Mr. Campbell: What were the failures, or the concerns, or the rationale that led to the decision to assert more oversight of what's been essentially a system independently run by the institutions themselves?

Mr. Le Pan: I think it is largely that we're seeing the development of these systems into reduced risk happening as we speak. Those really are relatively new. The Canadian Payments Association historically for wholesale payments has developed the paper bay system, the cheques that get cleared every night in the bowels of the buildings in Toronto.

The supervisory authorities - the Bank of Canada, the superintendent's office, and the Department of Finance - have sat down with the Canadian Payments Association as the association over the past year and a half or so was developing this large value transfer system. The supervisory authorities have specified some important terms and conditions from a risk-proofing perspective that they wanted to see.

We thought that rather than have that done, without any kind of legislative mandate, if you will, we ought to sort out who's accountable and put that in a statute.

Mr. Campbell: Just to clarify this, there's been no failure of the CPA; it's a fear of what might happen as things get more complex.

Mr. Le Pan: That's right.

Mr. Campbell: We're reasserting ourselves into the picture, if you will, at this juncture, but not because of any failure. It's fear of the systemic risk that you talk about that might be magnified or amplified by the operations of the payment systems.

Mr. Le Pan: That's correct. It's not something that's happened. This represents a development around the world too that's happening.

Mrs. Brushett: About security stock exchanges, would they be wholesale?

Mr. Le Pan: A stock exchange is not a payment system mechanism, because you buy securities through that but you're not actually clearing the money side of the transaction through the stock exchange. The stock exchange is sorting out the securities part of the transaction, so that inherently stock exchanges aren't really part of the clearing and settlement system.

The clearing and settlement system is the part that deals with the money side of when a stock transaction occurs. You think of the exchange deals with the exchange of certificates for stocks. They're actually immobilized generally or increasingly, but it deals with that side.

There's the other part, the part with the money on it, the part where the dollar flows on it. Where does that happen? That happens through the payment system so that the big amounts of the money flows related to stock transactions would occur between the investment dealers, say, at the end of the day or the next day as they add up the total amounts that they may or may not owe each other, or that they may owe banks or insurance companies that have engaged in these kinds of stock transactions. Some of that may be for their own account and some of it may be for clients.

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Those money flows, if they're large enough, would flow through the large value payment system. If they're not large enough, they probably wouldn't flow through the large value part. It's more the oversight of the money side of the transaction. The stock exchange side is regulated by provincial securities commissions, by the self-regulatory organizations, and we have no desire to get into that.

Mrs. Brushett: Even though the Chicago exchange may stay open 24 hours a day, it's the payment side that you have to finalize within 48 hours, or whatever.

Mr. Le Pan: Whatever the rules are, exactly.

The legislated mandate philosophy is on my next page. We've talked a little bit about it for accountability. It's also proposed that the language of that mandate would clarify that failures of institutions don't by themselves mean that the supervisory system has failed.

The government's white paper makes it clear that the government does not expect a zero-failure system. In order to get to a zero-failure system, to guarantee that there would never be any failures of financial institutions, the level of regulation and supervision would have to be so high that, in fact, we would stultify the kind of initiative that's desirable here, because we do want a competitive flexible system as well. The issue is always a balance between those two, but it's pretty clear that we're not proposing at this point a zero-failure system.

I've included the mandate, which we don't need to talk about. Somebody can read that. One important thing that's in there is that it explicitly provides a legislative statement that part of the purpose of the office of the superintendent is to take prompt, and I underline the word ``prompt'', action.

One of the aspects of that mandate is the statement that it is part of the job of the Office of the Superintendent of Financial Institutions to take action when there is a problem promptly, expeditiously. I can't remember the exact word, but the notion of early identification of problems and prompt action is the essence of what's in the proposed mandate. That comes back to the accountability of that office and the supervisory system.

The Chair: Were you prompted strictly by the Confederation Life failure?

Mr. Le Pan: No.

The Chair: There must be a feeling that in the past there has not been prompt action; in other words, if it's not broken, don't fix it.

Mr. Le Pan: There were reports from former incarnations of this committee, the Senate banking committee, and others, that felt it would be desirable to make it explicit that prompt action is important.

I'm not going to point fingers, Mr. Chairman, here or there. It's easy to have 20/20 hindsight.

The other aspect of this is that I've seen, from a little bit close and a little bit far, some of the problem institutions as they've come to their ends. The incentives here are for the people who are running those institutions as they get to the end to want to delay to find a solution. That's a natural human instinct. They think maybe something will come up, or they need another $50 million of capital and they're talking to people who may provide it, but it isn't quite here yet, or the money's in the mail.

I'm not blaming the people who run institutions or who are owners of those institutions, but that is their natural incentive.

The question is ultimately that when you get to a problem and when the problem is severe enough, who is the burden of doubt given to? Do we give the burden of doubt to the owners and managers to work the system out, or do we give the burden of doubt to the superintendent to move in and say, sorry guys, the game's over, and we have to save money for depositors and policyholders? Part of this is saying that we have to put the policyholders and depositors first.

Mrs. Stewart (Brant): The idea is to focus solely on that decision, irrespective of circling issues that may be political, or who knows what. So that's the directive here?

Mr. Le Pan: That's right. Exactly.

From my observations over five or six years, my very personal opinion is that inherently it has been assumed that if there is a failure of an institution, whether it actually leads to liquidation or whether it is an assisted merger, that by itself means the supervisory system has failed.

That's not a healthy environment either for the people who are running the supervisory system. If that's what they think the accountability standard is, then it's their incentive to try to be part of the belief that maybe there's another solution out there. This is a related kind of thing. The psychology of this is sort of important.

Mrs. Brushett: How do you measure the quality control of how well the system works, whether it's the supervisory portion -

Mr. Le Pan: Are you asking how to measure the quality control?

Mrs. Brushett: Yes, eventually or periodically.

Mr. Le Pan: We review it. We do post mortems. I'm sure this committee will want to hear from the supervisors after there have been problems.

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One of the other things we've done as part of this package is that we've put out a so-called guide, and an illustration of it is in the back of the deck. It's a guide to the intervention process. That basically lays out in a much more transparent way than in the past what the process is that the superintendent and the Canada Deposit Insurance Corporation go through in dealing with a problem financial institution.

It shows what the steps are from sort of no problem up to imminent collapse and then closure, potentially; what to expect to have happen; what the normal thing is to have happen at those various steps. That's both a transparency thing for institutions themselves, for members of this committee, and there are certain things that are specified. When you get to a certain stage, while the institution is supposed to provide a business plan about how it's going to raise the capital and -

Mrs. Brushett: Will this be based on classic cases like Confederation Life?

Mr. Le Pan: It's been developed based on the experience of past history.

Mrs. Stewart: Just for further clarification, this is saying that we are directing and expecting the office of the superintendent to look solely at the facts as they stand for that particular institution, irrespective of whether we're in the middle of an election.

Mr. Le Pan: Yes, that's their job.

Mrs. Stewart: Is that solely and completely, with nothing else clogging their view?

Mr. Le Pan: That's correct.

For closing an institution, the system has long contained a ministerial involvement under the current statute. Before the superintendent can take control of an institution, the minister has to be satisfied that there are the conditions as set out in the statute, fundamentally that financial problems exist, and that there's a possibility for representation of the institution.

We're actually making a minor change in that system to change the grounds on which the minister becomes involved to public interest, as opposed to requiring ministers to actually make a solvency judgment. It will make it clear that ministers are all -

Mrs. Stewart: It's a move from the solvency judgment and from the directive here.

Mr. Le Pan: Ministers would still be involved if they thought there was some public interest reason why the superintendent shouldn't take an action, but that's going to be in a very narrow number of cases, if ever.

Mr. Fewchuk: Do we also have a power struggle here?

Mr. Le Pan: No, I don't think so. It's not so much a power struggle as a sorting out of roles. The superintendent's role is to worry about safety, soundness, and solvency.

The minister's role is to be a check on the system. Suppose there had been some kind of abuse of due process for some reason or other. I'm not saying it's going to happen, but it could happen. That's included in the standard public interest kind of notion.

If for some reason or other there was some kind of overriding public interest as to why an institution ought not to be closed, I think realistically in that situation it's because the government is prepared to put money in the institution. It is my own personal estimation, because otherwise how do you say that the superintendent has decided that an institution is sick enough that it's got to be closed or merged with something else? You at least want to provide for that possibility, and people do need a bit of due process here.

Mrs. Stewart: Will the superintendent make that judgment prior to ministerial intervention?

Mr. Le Pan: The system that's set out here is that the superintendent comes to a judgment as a realistic matter. The draft statute is in the back of the white paper. The statute then says that the superintendent may apply to a court to wind up an institution, provided the minister is not of the view that it's not in the public interest, or something like that. It's a double negative. They'll talk beforehand.

Technically, it's not that the minister comes to an advance judgment, then he hears a bunch of institutions. The superintendent does his case-by-case based on facts and institutions.

Mr. Fewchuk: Is the superintendent appointed? Who hires him, or how does he come about his job?

Mr. Le Pan: The superintendent is appointed. It's a Governor in Council appointment for seven years.

Mrs. Brushett: I want to just go back to the superintendent one more time. Would he do an annual review of the institutions and rate them - triple star, one star, or whatever - so that there is an ongoing record or report card?

Mr. Le Pan: Yes. In fact, under the statute there's a requirement for there to be regular examinations of institutions. The superintendent has a big examination staff. He uses outside credit consultants, and so forth. He does regular examinations of institutions. There is a rating system that takes into account capital assets, liquidity, management of the institution, its earnings record, and so forth.

Mrs. Brushett: What about an institution that was giving too many foreign loans to a country that's probably not capable of repaying them? What does he do in that instance? Does he sound a warning bell, or does he put a halt to it completely?

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Mr. Le Pan: The guide to intervention that I referred to, which has now been released publicly, makes it clear that basically it's a hierarchy - a staged intervention. The statute allows the superintendent to actually direct a compliance order, which is a legal instrument, if you will, to an institution to say, do not do that - stop. But normally you don't start there. You start by saying to the management or the board of directors: Here's your results of the examination. This is how I rate you. Here's where I see the problems are; now I'd like a response. I'd like maybe an undertaking or a commitment that you're going to work off this problem over the following x period of time or not do any more of it.

So you normally start with that kind of process, and then you only get to the more formal.... Now, that's in cases in which the institution is still in compliance with the statute. The statute has specific limitations in some areas, and obviously the institution's done something that's offside what's legally permitted.

Mrs. Brushett: Would he also step in, for example, if he looked at the balance sheet and said, they're investing a lot of money in real estate these days, and I'm not sure they've got so much here. So is he going to step in and maybe make judgment calls and let the board of directors....

Mr. Le Pan: The mandate makes it clear that the superintendent's business is not to micro-manage the institution. Ultimately, it's the board and management. The superintendent is going to tell them things, but the superintendent is not going to say, you ought not to be in that property or whatever. But the superintendent issues guidelines on concentration, for example. So the superintendent says, on concentration of lending, institutions are supposed to have a so-called prudent portfolio under the law. There are guidelines as to what constitutes prudent. The superintendent's going to say that, if the institution is off of what's prudent, there's a problem here. What are you guys going to do about it? But ultimately, the superintendent's not going to run the institution. We've left it to the management and board to be responsible for running the institution.

The superintendent can indicate areas of concern and will do so, and there's some fuzziness here inherently. It would not be realistic, with the costs of the superintendent running all these institutions and knowing all the details.... Very key to our system is a reliance on outside auditors to find out what's going on in the institution and to report. So that's also part of our system, which is a substitute, if you will.

In the U.S. you'd find many more people on the examination side - much more micro-management. The costs, for example, for deposit-taking institutions in the U.S. of the supervisory system relative to the assets in the system are about nine times higher than in Canada, because they have much more micro-management than we do. We have much more reliance on guidelines kinds of approaches.

Mr. Fewchuk: So here we are, the Canadian taxpayers, backing this system and not having much say. Here the board can do what it wants.

Mr. Le Pan: The Canadian taxpayer isn't really backing -

Mr. Fewchuk: The losses; well we are - up to $60,000.

Mr. Le Pan: Yes, but it's not being paid by the Canadian taxpayer. That's all being paid by the institutions.

Mr. Fewchuk: We're not helping out the depositors.

Mr. Le Pan: No, we're providing protection up to the $60,000, which in fact can be more, depending on how you work it.

Mr. Fewchuk: And if there is no money, where does it come from?

Mr. Le Pan: Back to your question of who's paying for this system. Fundamentally, this system is not being paid for by taxpayers. Indeed, a proposal in this legislation will actually make it possible - and it will be government policy - for CDIC not to borrow from the Consolidated Revenue Fund any more, but to borrow in financial markets. This system is fundamentally being paid for by some combination of institutions and depositors. It's not being paid for by taxpayers.

The other aspect of our not having much say in it - we have a lot of say in it. When you look at the Bank Act and the regulations and get the superintendent in here with his guidelines.... In fact, to some extent, the complaints from the healthy institutions are that the system is not as efficient as it should be, because there may be some regulations or rules or whatever that are too much and that may be unnecessary from a safety and soundness point of view.

Mr. Fewchuk: I just wanted to get that clarified. Thank you.

The Chair: Herb, you've missed one of the best presentations this committee has ever had, but it's nice to have you here.

Mr. Grubel (Capilano - Howe Sound): I hope you forgive me for not having been here. I just had to stay with some other meeting. I didn't sleep. I also have some background on this, so I have a couple of questions. One of them is, why the heck did you have no co-insurance?

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The Chair: No what?

Mr. Le Pan: No co-insurance.

Mr. Grubel: Did you go through that already? Oh, you're still running through this.

The Chair: We're not here to roast them or to criticize them. We're just here to learn.

Mr. Grubel: I would just like to understand what a neutral technical adviser has to say about this essentially political decision. Or is there any economic argument you can think of that would be in favour of having no deductible?

Mr. Le Pan: Shall we deal with that, Mr. Chairman? I'm happy to deal with that now, if you like.

The Chair: Nick, it's entirely up to you. You've sort of got a drift of where we are - like all over the map.

Mr. Le Pan: Let me spend a few minutes on deposit insurance and then come to the question, just so other committee members can -

The Chair: I'll have to leave it up to you. What's the best way for us to proceed?

Mr. Le Pan: If you go about four or five pages further down.

Mr. Grubel: Please go ahead systematically. It was my impression when I came in here, the way the questions were going, that you had been through all of it.

Mr. Le Pan: Yes, we've been sort of mixing and matching. That's fine.

There's a page entitled ``Changes to the Deposit Insurance System''. For committee members, it's about four pages down from where we were. I'm sorry I didn't number them.

The white paper is proposing some changes, and in other areas that Mr. Grubel has asked about, it's not proposing any.

The first change that is being proposed is to allow premiums to be related to risk. We talked with committee members a few minutes ago about how CDIC is financed: a premium of one-sixth of one percent. That is a flat rate premium on all covered deposits. It is not related to risk.

Normally, in an insurance system, if you are a heavy smoker or have drivers at different ages or a history of accidents, you'll pay a risk-related premium. The idea here is to amend the statute to allow CDIC to vary the premiums based on the risk of the institution. It will never be a perfect measure of what the riskiness of the institution is, because, for the institution that's two weeks from being closed, you couldn't charge a big enough premium, but we think it's very important that there be a financial signal to an institution when its riskiness is not the same as the norm. It's a very important message to the board of directors and management if CDIC says, you're paying a premium that's higher than everybody else's.

Mrs. Stewart: Are you going to talk about the impact on the investors with that directive?

Mr. Le Pan: On the investors?

Mrs. Brushett: The investors will skip out, I guess.

Mrs. Stewart: That's my point, precisely.

Mr. Grubel: Investors?

Mrs. Stewart: Depositors. Sorry.

Mr. Le Pan: Depositors will? I don't know. It's fascinating. The experience with the failures of trust companies is that in many, many cases, by the time they were closed, 95% or more of the deposits were actually below the insured limits.

Mrs. Stewart: Yes, but let's just think about this. You're not just going to change your premiums at the last moment.

Mr. Le Pan: No, that's right.

Mrs. Stewart: You're going to have variable premiums.

Mr. Le Pan: Exactly. There are going to be variable premiums.

Mrs. Stewart: The depositor is going to look at that and say, what's the message I'm going to take from this? I'm just asking you to respond to the indications to the depositor and what that does to the marketplace.

Mr. Le Pan: The experience in the U.S., which has this system now, is that the actual level of riskiness of institutions is not widely disclosed. It may be known, but it's not front and centre. We have not seen vast runs created by this kind of system.

Mrs. Stewart: So you don't see this as a tool of social audit or practical audit?

Mr. Le Pan: I see it as a message to the board of directors and senior management. I don't think it's going to cause any more problems than the fact that you've got rating agencies changing the ratings on these companies from time to time, which is known in the marketplace. You've got people in the marketplace who may say, I think this institution is less risky or more risky than others.

I don't really see this as causing a lot of big run kinds of problems. I see it more as a message to the board and senior management.

Mr. Discepola (Vaudreuil): But would there be a message in place to advise the depositors that a change had...?

Mr. Le Pan: No.

Mr. Discepola: Is that not important? If I'm a depositor with even $60,000 in an institution, should I not be advised that my bank has had its credit rating, or whatever you want to call it, changed?

Mr. Le Pan: Well, there's a lot of information out there, and we're proposing to put out more information on disclosure of financial conditions of institutions.

There are intermediary institutions that are doing things for public consumption. I think the insurance track, for example, has been doing a very widely publicized raiding of insurance companies for the past couple of years based on publicly available available information, some from the institution but some from the supervisor. That's picked up through the agent force, for example.

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Ratings from rating agencies are around.

Mr. Discepola: I am talking about protecting the consumer.

Mr. Le Pan: That's what I'm talking about, too.

Mr. Discepola: When I buy an insurance policy, I normally put it away in my safety deposit box or whatever and never look at it until something happens. In the meantime, if the insurance company suddenly has a bad credit rating, I should be advised. The same thing with the banks. If I have term deposits or whatever, they are usually there for four or five years. If something changes in the interim, it seems to me that maybe there should be a mechanism to advise the depositors.

Mr. Le Pan: I guess the key question here is whether it is possible to boil down the financial situation of an institution to one number that could be put out by the authorities to all depositors or policyholders, and my belief is no.

These proposals are founded on the basis that policyholders and depositors do have to take some responsibility themselves. You take the failed trust companies. Not everybody ran immediately, but people were aware. It was in the papers.

Mr. Discepola: Is there an obligation for the banks to send out their financial statements to the depositors on an annual basis?

Mr. Le Pan: Not an obligation, no.

Mr. Discepola: Then how can depositors possibly take it upon themselves to...?

Mr. Le Pan: Ask for it.

Mrs. Brushett: Would this be disclosed at an annual meeting?

Mr. Le Pan: Sure.

Mr. Discepola: Only shareholders are invited to annual meetings. Deposit holders aren't. Banks have too much power. We've got to figure out -

Mr. Le Pan: The essence of the proposal in this paper is that we are going to force institutions to disclose more information about their financial condition, and not just to shareholders. I have talked about the role of intermediaries who then often put stuff out in the public press. Also, you get somebody's view of the relative strengths of the various banks and so forth.

I personally think that is a better way to get information to the public than, for example, to put 40 pages of XYZ's annual report in the mail. That's my gut feeling about how people seem to get information these days. Under these proposals, we are releasing a fair amount of financial institution information, including regulatory capital levels of these institutions, to public data bases. They get picked up by not only the Moody's and Standard & Poor's of the world, but by the tracks of the world. That stuff gets a fair amount of play when people do that and it shows up in a lot of papers, not just the major national business papers. It shows up in other papers.

Mr. Grubel: It would show up in all the financial statements, and it would be an easy step from there for somebody to calculate what their rating is?

Mr. Le Pan: It is not clear whether it is going to show up in the financial statements.

Mr. Grubel: Why wouldn't it?

Mr. Le Pan: You've still got to do the math as to exactly how they got there.

Mr. Grubel: But Moody's or some other pro can offer a service.

Mr. Le Pan: But the question is, who's ahead and who's behind here? There's already a lot of determination about financial conditions out there now. You go and get the ratings from Canadian or foreign rating agencies on the paper of these institutions, there's a difference.

Mrs. Stewart: Let's talk about that.

The Chair: I am sure they make mistakes.

Mr. Le Pan: They make mistakes.

Mrs. Stewart: When you use the phrase, who's ahead and who's behind, one of the critical issues here - and it goes back to our conversation about the payments association - is the issue of timeframe. As timeframes in all these decisions are shrinking to, at some point, minutes, and we look at the structure we're putting in place - at this stage, we'll do this; at this stage, we'll do that - can you in fact, as these timeframes shrink, create a system that can be at all or nearly responsive enough to give the superintendent the ability to respond to the mandate we're giving him? Is it really even going to be possible?

Mr. Le Pan: It takes under 24 hours to close an institution. It doesn't take very long to issue a compliance order.

Mrs. Stewart: That's precisely my point. We are sitting here and we are going to watch this and at different stages we're going to change their premium rates. Is this fundamentally an impossibility as our timeframes in all these decisions really are...?

Mr. Le Pan: I don't think so. It depends what it is that is an impossibility. We have a system, and we think we're enhancing it, that's got some incentives for the various people to act when there's a problem. This is not a system in which we look only to one group of people to act. It's like the discussion we had before. The boards, the management, and so forth have major responsibilities here, not only the superintendent, the auditors, and so on.

Are we creating a system in which we are going to have...? I think we're creating a system in which, hopefully, there are sufficient incentives for the various players to get their act together in most of the cases, if not all.

Mrs. Stewart: Even in that, how fast can an institution go, for example, from stage 1 to stage 4 in your hierarchy?

Mr. Le Pan: Realistically, it takes a while.

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Mrs. Stewart: Meaning what? How long did it take Central Guaranty, or how long did it take Confederation Life?

Mr. Le Pan: A few years.

Mrs. Stewart: Years?

Mr. Le Pan: Two years. Two plus. With Central Guaranty, for example, one of the issues was they didn't even have all the systems together from all the acquisitions to back off the systems. It required seven or eight press companies to put it all together. It had some time to fix that kind of problem. That affected basically its management information system and what its management knew was going on.

From one to four, or through whatever stages, is not one month. It's one month when you have a BCCI closed in Canada or we've closed a couple of small insurance branches in Canada because of problems in their huge parents abroad. Then the issue isn't the intervention; then the issue is, have we made sure there's a positive enough capital number in Canada so we can protect Canadian depositors, and the answer has been yes, because we made sure there's sufficient money here to cover liabilities in Canada.

The clearing system stuff is different from the financial health of an institution. With the clearing system stuff, you inherently have big amounts of money flowing back and forth every day. But a lot of the problems in these institutions are arising from problems of asset quality, management, lack of information systems, and so forth.

Mrs. Brushett: I see a great potential here for the risk of an institution becoming so conservative that it wouldn't take a loan. It's bad enough now to get our banks to loan money as it is, and if the institution's credit rating is the least bit questionable, there will be great competition for one bank to say it is better than the next one, so it stops lending money completely and takes all deposits.

Mr. Le Pan: Well, they do need to earn something on the asset side of the balance sheet.

Mrs. Brushett: I see this as a great risk in where we're at today with lending.

Mr. Le Pan: Yes, that's why this is an art, not a science. The supervision and regulation issue is an art; it's not a science. You're right, in that, if we have the rule book this high, and there are all kinds of dollar mechanical limitations - you can't do this, you can't do that - then yes, there could be a problem. The risk-based premiums we're talking about here are going to be fairly modest. We're not looking at tripling the premium on somebody for this.

Mr. St. Denis (Algoma): My other question was answered. It seems to me that the bottom line is, in order not to skew the system - you talked about the big, high, thick rule books - so that the state is overly involved is to allow the consumer ultimately to be as responsible as he or she can be and the marketplace to ultimately decide or determine the stability of the system.

Mr. Le Pan: That links directly into Mr. Grubel's question. We have a system that fundamentally says, up to $60,000, we're not going to impose losses on individuals. One of the main arguments for keeping that system and not having co-insurance, whereby an individual would have to bear some of the costs up to $60,000 - you could think of a simple co-insurance regime - is that we cover an individual only for 90% of their loss up to $60,000, so they bear the first 10%. You could say the first, the last, proportional all the way - whatever. With simple co-insurance, they'd bear 10%, let's say, or 5%; pick a number.

One of the main arguments for keeping the current system is that, inherently, there will be a significant number of individuals who, no matter what information you put out, will not be able to make their own solvency judgment about the health of individual institutions. That's very hard to do.

Even if we could magically boil it down to one number, that one number will be wrong sometimes. There will be people who don't understand that one number. There are lots of people in Canada who don't understand a rating. If you called it A, B, C, D, it would still take a significant amount of time to explain it to them. They might forget it and not look at it. They don't read. So that's probably the main argument for no co-insurance.

Can you run a system where you say, we're going to provide all kinds of information and there's going to be co-insurance, so people bear a financial risk? Yes, that system can be run; it's run in some other countries. One of the major arguments against that system in the Canadian context is we will not be prepared to get - or we've not seen that we can get - disclosure to a level at which we think it's appropriate to have all these people taking responsibility for that loss. The idea is that you protect the small people, protect the payment system, protect the demand deposits so people don't feel they have to yank out their money instantaneously. That's the sort of structure, if you will.

I don't know whether that's helpful. I want to come back to his question specifically, which I haven't fully answered yet. Go ahead.

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Mrs. Stewart: I'm trying to mix ideas here, probably, but, giving your explanation on co-insurance and the inability of Jane Stewart to make a reasoned decision on whether I'm going to invest here or not and pay my insurance is one thing, but even in the context of OSFI and going back to what happened with Central Guaranty.... Just looking at the framework here, it looks like, in January 1992, we were saying everything's okay, and then it was April when we took action. Even in that context, who's to say that in this complicated world of things, the superintendent even knows or has the information or is prepared to make the judgments that need to be made?

Mr. Le Pan: Well, I guess that comes back to what's the structure, who are the people, and what's the incentive? I'm not going to guarantee there will never be any failures.

Mrs. Stewart: Is it a question of having the tools - the mandate being one, obviously?

Mr. Le Pan: Yes. The mandate, the tools, and the will to use them.

Mrs. Stewart: Yes.

Mr. Le Pan: Let's go back to the royal commission coming out of the western banks - Judge Estey - the mandate, the tools, and the will to use them. We're adding a mandate. There are some minor adjustments to tools, but when you look at the panoply of tools that are there now - everything from guidelines and rules on assets and investments and so forth to directives of compliance, which can basically say, sorry, you cannot do this, that, or literally anything to the reliance regime and even the former and current superintendent who was asked explicitly whether he wanted more regulatory tools.... He knows what the job is. The answer is that there are a few minor changes here, but there are not a lot.

There are going to be cases in which the superintendent doesn't necessarily have all the information, but they get a lot. I'm not sure how much more comfort I can give you. This is an art, not a science. There are no 100% guarantees in this world or with this system.

Let me come back to his question. Your question, basically, is what is the argument against introducing co-insurance? Right?

The Chair: Could you explain what co-insurance is, please?

Mr. Le Pan: Okay, co-insurance would be a system in which part of the loss to an individual depositor or an individual policyholder in a failed institution would be paid by that policyholder or depositor. So instead of covering losses in full up to $60,000, the deposit insurance corporation would cover 90% of those losses; the remaining 10% would be to the account of the depositor. So if the depositor had $50,000 in the institution at the time the institution failed, the depositor would get only $45,000 back; the other $5,000 would be lost. That's the essence of the co-insurance regime. Part of those liquidation costs go to the depositor.

That system exists in some European countries. It exists in the United Kingdom and in Germany, for example, and I believe the European Community directive on deposit insurance involves some co-insurance.

It does not exist now for federally regulated financial institutions. It does not exist for the credit union movement, either in Quebec or in the rest of the country. In fact, those institutions are normally guaranteed up to a higher number than $60,000.

It does not exist in the United States. The United States has a limit of $100,000, as I recollect.

One argument in favour of that system is fundamentally that it would impose more market discipline on the regulatory system and structure, as well as on the financial industry. The second argument in favour is that it would reduce the cost of the deposit insurance system. You're fundamentally rearranging the costs of a failure. The costs of a failure are whatever they are once it's happened. In our current system the costs of that failure are paid by all depositors, because they're charged back through the premiums of CDIC to all covered depositors. So they're paid by all the depositors either in that institution or in all the institutions that remain after the failure.

In a co-insurance system, part of those costs would not show up on CDIC's balance sheet or income statement as a deficit; they would show up in the pockets of individual depositors. So, generally, there is more payment by them and less payment by depositors.

The arguments against are, first of all, that there is a competitive equity unless you introduce co-insurance to all the institutions that compete for money. So if you have it in the CDIC, but you don't have it in QDIB, for example, or you don't have it with the credit unions, there's an interesting little issue.

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But let's leave that aside. It's important; it's a non-negligible issue, and for some institutions, in particular markets that go head to head - we'll say the credit union movement - it would be a big issue if provinces didn't go along, because it would be basically for the QDIB or the credit union movement. That would be a decision of the provinces, not of the federal government.

The second argument, historically, was that introducing co-insurance would make it harder for smaller institutions and smaller trust companies to flourish, survive, or whatever, and that would promote further concentration in this sector, which would be a bad thing.

There is very little evidence that I'm aware of, none domestically and not much internationally, on the impact of co-insurance regimes on smaller institutions. Small institutions feel quite strongly - the trust companies, for example - that it would be very detrimental to their position, because even if they are well-managed, they would seem to be less safe than the big banks and that implicitly there would be some kind of sense that the big banks must be safer even than very well-managed, smaller trust companies. Therefore, they would be discriminated against in the marketplace, and competition would suffer. They would point out that they have been the source of a number of innovations in the system for consumers over the years - banking hours, longer hours, more kinds of transactions, and so forth.

The third argument against is basically the consumer information issue that we've touched on earlier. Is it right in policy, political, or whatever terms you want to use to essentially say to depositors who may be unable to read a financial statement that they have to come to some judgment about the health of institutions? Implicitly, the critics of co-insurance say that if you're going to impose a 10% loss on somebody, you're essentially saying to them that they have to figure out whether their institution is safe or not. It may not be reasonable to do that. That's a policy judgment call.

The only other part of the debate on co-insurance that's existed historically has been an attempt to go back to first principles. The issue is to determine what the purpose of deposit insurance is and to try to figure out from first principles whether, if you know the purpose, there should or there should not be co-insurance. I haven't found that discussion very helpful, because the purposes of the deposit insurance system, when you go back and look at the record, actually turn out to be varied, so I don't think that's a very helpful way.

Some people, though, who strongly support co-insurance would indicate that ultimately the only really important reason for deposit insurance is to prevent instantaneous runs at institutions that could de-stabilize the system. Therefore, you should cover the chequing account deposits that people can move instantaneously, but there is no argument for covering longer-term demand deposits. So you get into that kind of debate.

Ultimately, as Mr. Grubel's recognized, this is a political decision. Ministers looked at all the arguments, they listened to a lot of people, and they basically said they're not convinced there's a strong enough case to go to co-insurance, particularly in light of the various factors against, and they made a judgment. I can argue both sides. I've seen all the debate on this kind of stuff.

The last point on question four is, for the people who don't like co-insurance, there's not much evidence about what co-insurance would do to small institutions. Equally, for the people who are for co-insurance, there's very little evidence about how much market discipline it would actually provide. So it's a bit of an act of faith that it would actually promote some discipline.

I have one strongly held view about co-insurance. There is no way in the world, in my judgment, that you can go to co-insurance without a clearly well-functioning disclosure system. We're only starting to put a fully - and I would want to have it operating for a period of time before you actually start to impose the financial losses on people. So I think, in fact, if you want to come back to the co-insurance issue, step one is to get the disclosure regime that we're enhancing in this package in place, then you can get a sense of how it operates. I think they go hand in hand, and a lot of people who would promote co-insurance do not spend what, in my judgment, is adequate attention to the disclosure that has to go along to support it.

The Chair: Can I just interrupt here? We have about 10 minutes left before the room is wrested from us. Maybe members have questions, but it's obvious to me that you're only about half-way through the presentation.

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My feeling is that you should maybe take control of our education and the greening of this committee and maybe keep us in your hands, but we'll intervene. We'll leave it up to you to get us back on track any time you seek that. But I'm also going to propose that instead of hearing other witnesses next week, we have another session next Tuesday morning with Mr. Le Pan, Mr. La Brosse, and Ms Avenoff.

Mr. Le Pan: I would be happy to come back.

The Chair: Would that meet with your approval? Okay. Thank you.

Mr. Le Pan: Let me just touch on some highlights of the rest of this, and then we can come back to it next week.

Two pages before the deposit insurance regime, there is a little page on enhanced disclosure. We think that will actually by itself encourage a bit more market discipline because the institutions, if they have to disclose, will think about what they're disclosing. If you force an institution to disclose its regulatory capital position, that provides an incentive for the institution to make sure its regulatory capital position is in good shape.

Enhanced consistency across sectors. The insurance industry has not disclosed anywhere near as much as the banking industry or the trust industry recently. There is going to be disclosures by OSFI or the financial institution. The legislation to be tabled puts a lot of this in regulations, and we're doing a lot of work on what is going to be in those that we can talk about later.

Other regulatory matters. This package does include some enhancement of the power of the superintendent.

The Chair: Excuse me, Mr. Le Pan. What page?

Mr. Le Pan: Enhanced disclosure, two pages previous. I should have put numbers on these, Mr. Chairman. I apologize.

Now I'm on the page after that, under ``Other Regulatory Measures''.

There are two or three proposals in the white paper that will be contained in the legislation, dealing with corporate governance.

One is to require that a federally regulated financial institution - that's what FRFI means - and its unregulated parent company have separate boards, that there be independence between those boards. There can be some overlap, but there be some independence; a third, I think, has to be independent.

Mr. Fewchuk: What does FRFI mean?

Mr. Le Pan: Federally regulated financial institution. I emphasize that this is for federally regulated.

There's a whole series of provincially incorporated companies, very important in the life insurance industry in Quebec, for example, in the trust industry in Ontario and Quebec and I guess one or two western provinces. None of this touches those guys. We're not intruding on provincial jurisdiction here.

There are proposals we should go into in some detail to allow the superintendent to veto appointments of directors of troubled institutions. I don't need to deal with the actuarial stuff.

An hon. member: Those that are in trouble?

Mr. Le Pan: Troubled. Problemed.

For consumer disclosure reasons, the last item, we've had some problems in the past with institutions such as Royal Trustco. They aren't regulated. It's only the trust company that should use those kinds of words.

Deposit insurance system, we've talked about.

I think, Mr. Chairman, we've talked about clearance settlement. Maybe it would be helpful to leave restructuring of insurance companies until I come back, because that's quite a technical thing.

I could talk about policy owner protection now, which is the last page, or on Tuesday, whichever you would like. There will be questions about that, I am sure.

The Chair: Let us take a break now, then, unless any members have some questions on what we have.

Mrs. Brushett: What does Trustco mean, where you say it shouldn't be used. What's the difference?

Mr. Le Pan: There was a company called Royal Trustco. There was another company called Royal Trust. Royal Trust was the trust company. It was the regulated company. There was an unregulated holding company above it. People who had money in Royal Trustco may have thought it was a regulated company, but it was not.

Mr. Discepola: On the case of co-insurance, you're saying that you're not proposing co-insurance.

Mr. Le Pan: Correct.

Mr. Discepola: I agree with it technically, right now. I mean, I haven't thought about it too much. You're saying if co-insurance were to exist, only the depositors in that institution would bear the consequences of a failure for that institution, whereas right now it is shared equally throughout.

Mr. Le Pan: Not only the depositors. Let's suppose it was a 10% co-insurance system. So you bore 10% of the loss. Now, if the loss in that institution is 20%, you will bear the first 10% and the system overall will bear the second 10%, because you'll get paid 90%.

Mr. Discepola: There is still a risk.

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Mr. Le Pan: You will get paid 90%, but the assets will be worth only 80¢ on the dollar, so that difference between 80¢ and 90¢ has to be made up by premiums on everybody else.

Mr. Discepola: Why the magical figure of $60,000? How many decades has it been $60,000? Why hasn't it increased? I presume -

Mr. Le Pan: The $60,000 dates from 1980. The average deposit in the failed trust companies was $20,000, something like -

Mr. Discepola: Is it not cause and effect? Since there's only $60,000 coverage people won't put too much money in deposits?

Mr. Le Pan: I don't think so. If that were the case, we'd see most deposits between $50,000 and $60,000. We actually don't. We see most deposits clustering around $20,000.

Mr. Discepola: Is it just liquid deposits in terms of cash, or do you include term deposits?

Mr. Le Pan: Term deposits are included, too. Term deposits, GICs in a trust company.

Mr. Discepola: And the average of all those instruments is only $20,000.

Mr. Le Pan: Yes. In the three major failed trust companies, the average was $20,000. I think something like 85% or 90% were under $30,000. If you look at under $30,000, you get 85%. I can provide the committee with those numbers; 85% or 90% of the depositors had amounts less than....

Remember also there is separate coverage for RRSPs; a chequing account is covered separately. An RRSP is $60,000 deposit; your chequing account is $60,000; your term deposit is $60,000. There's separate coverage for RRSPs from the others and when you averaged it all together it was $29,000.

Mr. Discepola: All right. Thank you.

The Chair: Herb, do you have one more question? This is not going to be an easy one like the last one, is it?

Mr. Grubel: I'm not going to be here next week. I'm going to be abroad -

Some hon. members: Oh, oh!

Mr. Grubel: My trip is being paid. I'm getting an award for my past contributions to international economics, in Germany.

The Chair: Wonderful!

Mr. Grubel: They cannot do anything for me after that. In fact, I gave a paper at that institute on the following subject: the questions that Jane and others raised were that essentially you are asking bureaucrats to make all of those decisions and the model that I like, which has been around in the literature, is why don't we put the burden of making all of those decisions on the industry itself?

For the benefit of those who don't know it, this model goes as follows: All the government says is, you, the banking industry, have to develop your own deposit insurance. And the way it's backed is that everybody has to have a contingent liability equal to 10% of the deposit, or some such thing, to be drawn on if there ever is a failure. As for the rest, you administer it yourself and you have all the power to ask of your own members in this club, part of the condition for doing banking business in Canada is that you have to give disclosures so that this thing can be run properly with respect to co-insurance and all those other conditions.

So we have the incentive for getting the right information, getting the right publicity and so on with the people themselves, and we're just standing there as regulators on the very, very top.

The Chair: This is the way to deal with insurance companies as opposed to banks, is it?

Mr. Grubel: So the question is, was that considered and was it rejected and what is the main argument for rejecting that model?

The Chair: Just one second; that cannot be answered in 30 seconds.

Mr. Le Pan: I can come back the Tuesday afterwards, too.

Mrs. Stewart: Personally, on Tuesday, I will send you the report.

Mr. Grubel: And you'll report it.

The Chair: Mr. Le Pan, you have 15 seconds to answer that question.

Mrs. Stewart: Give it to us on Tuesday.

Mr. Le Pan: See you Tuesday. I can take advice. We can talk privately, if necessary, to follow up on what I say on Tuesday.

It's a good question, but it deserves more than 15 seconds.

The Chair: It goes to the very structure of some of the things we're going to be debating next week, because the insurance companies are doing it themselves; we're doing it for the banks. There's a competitive inequity, some people claim, and these are going to be very tough political questions that we have to resolve.

May I suggest to members...? I know you've all read it; this is the white paper. It might be helpful to review it for next Tuesday.

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Would these be useful questions to have raised for next week, for you to bring back to us a profile of some of the major players among the various four pillars, based on their assets and their industry? We will then know the names and the terminology that comes up. Could you also give us a list of the companies or institutions that have failed in the past; and the extent of public sector bail-outs; the banks we've bailed out, the institutions we have not bailed out? Maybe then we can look at some of the political issues that we as politicians will face when depositors or policyholders come to us and say, Hey, my money's gone.

Are there any other things that people would like to talk about next week?

Mr. Grubel: Whether we have any restrictions on multiple deposits by individuals. In the United States, organizations sprang up that made sure that if you had a million dollars worth in liquid cash like that, only $60,000 was in each and the moment there was any cloud over one company...if you were rich enough, you could buy that service and they moved it for you. Do we have that problem here?

Mr. Le Pan: There are some people who do multiple deposits, but in the failed companies we'll give you the numbers. It was somewhere less than 8%; between 6% and 8%.

Mrs. Stewart: No, but is there a specific service in the contract of the company itself?

Mr. Le Pan: I'm not aware of that service existing here, but I'll check. It may have developed.

Mr. Grubel: There is no way of protecting against that, is there?

Mr. Le Pan: No.

The Chair: Herb, might we suggest you send a proxy to receive your award, so you could be here with us next week?

Mr. Le Pan: If there are any other questions anybody thinks of that the clerk wants to pass along to us between now and Tuesday, we can see if we can dig out any numbers and so on.

The Chair: I think these issues are going to be profoundly more difficult than anybody imagined. It's going to be a long learning cycle for all of us, but it's critical that we start now on a relatively simple matter as we go into a review of the Bank Act in 1997, where everything that was done in the past is on the table again with all of the four pillars fighting among themselves for a bigger share of the pie. We're the ones who will have to make those decisions, and it will fall to us to make them.

In terms of the information you are bringing to us, could we look at which ones are federally regulated involved in the financial institutions and which ones are totally beyond our control, with a profile of what they look like and how they compare in terms of size and assets?

On behalf of all of us, I thank you for the start of something that looks like a lot of fun and a big challenge. Thank you.

We adjourn until next Tuesday.