Strengthening Competition in the Financial Sector: Submission by the Competition Bureau

March 21, 2024

On this page:

• Overview of the submission
• Introduction

1. Benefits of competition
2. Concentration in the financial sector
   • Strengthening Merger Review in Concentrated Markets
   • Regular Reporting on Concentration in the Canadian Banking Sector
3. Concrete pro-competitive measures to adopt swiftly
   • Recommendation 1: Adopt a consumer-driven banking framework at the earliest possible opportunity
   • Recommendation 2: Enable competition in mortgage-switching without a stress-test at renewal

• Conclusion
• Footnotes

Overview of the submission

The Competition Bureau (Bureau) is pleased to make this submission^{Footnote 1} in response to the Department of Finance (Finance) public consultation on Strengthening Competition in the Financial Sector.

Ensuring robust competition in Canada's financial sector has never been more important. This consultation occurs at a moment where Canadians are demanding more competition.^{Footnote 2} Indeed, concerns around affordability and Canada’s productivity performance have brought a renewed focus on the critical role of competition in the Canadian economy. The issues are particularly acute in the finance sector, where borrowing costs have rapidly increased to their highest levels in a generation.^{Footnote 3}

Against this backdrop, it is essential to prioritize competition in the financial sector. Pro-competitive measures should be one of the key levers that financial policymakers rely on to build a more resilient, dynamic financial sector, and better outcomes for all Canadians.

Consumer choice and the ability to switch providers lie at the heart of the competitive process. Unleashing consumers’ ability to switch financial service providers will help foster competition in the sector.

This submission recommends a focus on two specific actions aimed at lowering switching costs to meaningfully advance competition in this sector:

• First, the Bureau supports a regulatory design that makes consumer-driven banking (open banking) work for consumers and businesses in Canada. The Bureau encourages Finance to swiftly adopt a consumer-driven banking framework that will boost competition and innovation by challenging established providers and enabling new service providers.
• Second, the Bureau urges policymakers to allow uninsured mortgage borrowers to switch between federally regulated financial institutions so that they too may exercise choice and benefit from competition.

Before recommending these concrete measures to bring more competition in the sector, this submission addresses questions related to mergers involving large banks and concentration. It reports on the efforts to modernize the legal framework for merger reviews under the Competition Act (Act) and shares considerations on monitoring concentration in the banking sector.

This submission is informed by the Bureau’s advocacy and enforcement experience in the Canadian financial sector.^{Footnote 4}

Introduction

This consultation occurs at a moment where there are concerns around the overall state of competition in the Canadian economy.^{Footnote 5} Canadians from all corners are recognizing the important role of competition in their lives and want to see more open and competitive markets, particularly in the face of higher prices.

The financial sector is a crucial pillar of the Canadian economy, such that protecting and promoting vigorous competition in the sector is critical to the interests of all Canadians. Financial services accounted for approximately 7% of Canadian GDP in 2022.^{Footnote 6} Canadian consumers and businesses of all sizes rely on key players in the financial services sector to safeguard their financial security and complete essential daily tasks such as receiving or making payments, borrowing, spending, saving, and investing.

The Bureau is an independent law enforcement agency that protects and promotes competition for the benefit of Canadian consumers and businesses. Competition drives lower prices and innovation while fueling economic growth. As Canada’s competition expert, the Bureau assists government decision makers in promoting competition across the Canadian economy.

This consultation presents an ideal opportunity to advance pro-competitive measures that will help tackle Canadians’ affordability concerns and seize the opportunity to put in place a more dynamic financial sector that benefits all Canadians.

I. Benefits of competition

Canadians are struggling financially in the aftermath of pandemic-related economic fallout and inflationary pressures.^{Footnote 7} In a recent survey, 51% of Canadian households report having trouble or sometimes struggling with their financial commitments, and 71% said their debt increased by more than $5,000 in the past 12 months.^{Footnote 8}

In addition to ongoing concerns about affordability for consumers, the current economic landscape is marked by a renewed conversation around Canada’s relative decline in productivity and economic growth.^{Footnote 9} Not only do indicators point to a relative decline in productivity across the Canadian economy,^{Footnote 10} but there are clear links between a decrease in competitive intensity and lagging productivity.^{Footnote 11}

In a recent study of Competition in Canada from 2000 to 2020, the Bureau’s analysis found that Canada’s competitive intensity has fallen over that period, a finding that was reflected across all the indicators measured. Specifically, the Bureau determined that:

• Concentration rose in the most concentrated industries, and the number of highly concentrated industries increased;
• The largest firms in industries are being challenged less and less by their smaller competitors;
• Fewer firms have entered industries overall, suggesting many industries have become less dynamic; and
• Profits and markups have both risen overall, and these increases were generally greater for firms already earning higher profits and markups.

In this light, the Bureau urges policymakers to prioritize and actively nurture competition in the financial sector. A competitive financial sector plays a pivotal role in fostering better economic outcomes.

Competition is instrumental to the ongoing wealth and prosperity of Canadians. In a healthy, competitive market, businesses must work hard to win consumers by offering better prices, more choices and improving the quality of their products or services.^{Footnote 12}

Competition also serves as a catalyst for broader economic growth and a stimulant for productivity and innovation.^{Footnote 13} When competing to differentiate themselves, businesses are incentivized to invest in research and development, adopt more efficient processes, and explore creative solutions. This dynamic environment not only enhances the quality of products and services but also propels the economy forward, contributing to job creation and technological advancements.

The Bureau's consistent advocacy for pro-competitive measures in the financial sector aligns with the need for a comprehensive and proactive approach to competition, recognizing its pivotal role in enhancing consumer welfare, stimulating productivity, and fostering innovation in the financial sector and the overall economy.

II. Concentration in the financial sector

Finance’s consultation paper raises key questions about bank mergers, market concentration, and public reporting on concentration and competition in Canada's banking sector.^{Footnote 14}

Merger review is often the first line of defence in protecting competition in the economy.^{Footnote 15} It is a preventative tool that protects against the harmful concentration of market power, which can lead to other types of anti-competitive behaviours.^{Footnote 16} The Bureau shares Finance’s interest in protecting against anti-competitive bank mergers, which can have significant impacts on the economy. In its review of the then proposed acquisition of HSBC Bank Canada by Royal Bank of Canada, the Bureau found that:

• Certain financial services markets remain concentrated, with Canada’s five largest banks accounting for the vast majority of services provided to Canadians;
• There are high barriers to entry and expansion in many financial services markets; and
• Conditions in certain financial services markets may facilitate coordinated behaviour among firms.

This submission reviews the Bureau’s past recommendations on strengthening merger review, including the use of measures of market share or concentration as an indicator of potential concern. In addition to sharing the Bureau’s perspectives on concentration thresholds, below we discuss considerations regarding regular reporting on concentration in the banking sector.

Strengthening Merger Review in Concentrated Markets

Considering paragraph 94(b) of the Act, the Bureau’s role in the review of financial sector mergers has often been to provide a competitive assessment to inform the Minister of Finance’s decision to approve (or not) a proposed merger. The Commissioner of competition assesses the potential competitive effects of a merger transaction by applying the legal test set out in the Act.

An effective merger control regime can help Canadians access the benefits of a competitive marketplace.^{Footnote 17} The Government of Canada has recently taken steps to modernize the Act and strengthen the Canadian merger review regime. One important change is the repeal of the efficiencies defence,^{Footnote 18} which had previously allowed mergers that were harmful to Canadians to proceed.^{Footnote 19}

Additional amendments to the Act are also currently before Parliament. Bill C-59, Fall Economic Statement Implementation Act, 2023,^{Footnote 20} includes several proposals that may strengthen the application of the merger provisions in concentrated markets. The Bill proposes to repeal a provision in the Act (subsection 92(2)) that prevents the Competition Tribunal (Tribunal) from concluding that a merger is likely to harm competition “solely on the basis of evidence of concentration or market share”.

The Bill also proposes to make market shares or concentration an explicit factor that may be considered in determining whether a transaction is anti-competitive. Taken together, these changes may allow for greater weight to be placed on evidence of market concentration. The Bill would also identify the likelihood of coordination among competitors as an explicit factor that may be considered in merger review.

The Bureau was recently asked by members of the Standing Committee on Agriculture and Agri-Food to provide a submission outlining the most pertinent recommendations that the Bureau has made to strengthen the Act that have not been addressed by recently passed or pending bills.^{Footnote 21} The Bureau’s response highlighted two significant recommendations with respect to how the merger review framework could be bolstered through additional reform of the Act.

One recommendation relates to the adoption of “structural presumptions” in merger reviews. This would shift the burden to merging parties to prove why a merger that exceeds certain thresholds of concentration or market share would be unlikely to substantially lessen or prevent competition.^{Footnote 22} The other recommendation concerns Canada’s standard under the Act to remedy harms to competition from mergers. We are of the view that the purpose of a merger remedy should be to restore competition to the level that would have prevailed in the absence of the merger.^{Footnote 23}

The Bureau’s recommendations and analytical approaches do not, however, contemplate a “ban” on mergers involving particular firms, or where specific size thresholds are exceeded. Beyond being inconsistent with the Act, such measures may not be sufficiently flexible to properly identify anti-competitive mergers and would be at odds with the approaches of our international counterparts.

Measures of concentration are, however, useful indicators of potential competitive harm. For this reason, the Bureau has traditionally communicated thresholds below which it will generally not challenge a merger.

In assessing future transactions in the sector, Finance may wish to consider concentration and market share of the merging banks as relevant factors. Thresholds in this respect can serve as a useful signal to stakeholders. Finance may nonetheless wish to maintain the flexibility required to consider other market-specific factors, and the changing nature of financial sector markets, in identifying problematic mergers within its reviews. The Bureau’s competition assessments typically include a consideration of the relevant markets and market concentration.^{Footnote 24}

Regular Reporting on Concentration in the Canadian Banking Sector

Regular reporting on indicators of competition and concentration in the Canadian banking sector can bring both benefits and drawbacks.

In terms of benefits, monitoring the competitive landscape would allow policymakers to have a better sense of market trends. This, in turn, would let them react more quickly to marketplace developments, including through further study of specific issues and addressing any identified policy and regulatory issues. The net result would be more competitive banking markets. There is also an additional benefit from public data and research in financial markets for the broader public, including other policy makers, researchers, and the public.^{Footnote 25}

Better and more regular monitoring of competition would give Finance data to show how competition affects other market results. This would help policymakers balance competition and financial stability.^{Footnote 26}

Finally, monitoring and reporting would provide Canadians with transparency into the level of competition in the sector and the effectiveness of newly introduced pro-competitive policies and regulations.

In terms of drawbacks, notably, the process may impose costs on market participants, and it is possible that this burden is disproportionately borne by certain types of competitors. In addition, some research suggests that reporting statistics at a disaggregated level could provide some competitors with information that would improve their competitive position in the marketplace and risk having an adverse effect on competitive outcomes.^{Footnote 27}

Areas to Consider

When deciding whether to require regular reporting and monitoring on industry concentration, there are two key areas for consideration:

1. the scope of industry-specific measures of competition, and
2. the level of detail of the data collected

that would provide useful information on the state of competition, while balancing the cost for participants to provide this information.

These two areas of consideration are intricately linked. The level of detail of the data will inform which industry-specific competitive measures can be assessed. Alternatively, the industry-specific competitive measures can inform the level of detail of the data required.

In 2023, the Bureau published its state of competition report which looked at trends in measures of competition over the last two decades.^{Footnote 28} This report considers various performance and structural (concentration and dynamism) measures of competition and studies their evolution over time at the national level.

Other competition authorities have published similar reports.^{Footnote 29} These reports are broad in scope and compute many competitive indicators. By considering multiple indicators of competition, they can account for differences in how competition plays out in one industry versus another.^{Footnote 30} If Finance were to use these reports as a model, the types of measures to consider would need to be industry and question specific.

The World Bank published a report^{Footnote 31} that suggests using competition indicators other than concentration, based on recent academic research in the “new empirical industrial organization” literature. These indicators are focused on direct measures of bank pricing behavior or market power.^{Footnote 32}

In addition to the types of measures used to assess the state of competition, Finance should consider the required level of detail of the data to compute those measures, for example:

• the geographic markets (i.e., national, provincial, census metropolitan areas, etc.),
• the product markets (i.e., deposits, mortgages, savings, rates, etc.),
• the frequency of the data collected (i.e., yearly, quarterly, monthly, etc.) and
• the channels (i.e., in-branch, online, mobile application, etc.).

Finally, with consumer-directed finance on the horizon, Finance may want to consider indicators that could be used to assess the effectiveness of the legislative and regulatory framework. For example, Finance may consider reporting statistics on the uptake or accreditation of third-party participants, which could serve as a benchmark for the degree to which these regulations have eliminated barriers to entry. Additionally, statistics related to customer switching behavior and the adoption of new product offerings may be particularly useful for assessing the dynamism of the market.

III. Concrete pro-competitive measures to adopt swiftly

In the following section, we encourage financial policymakers to drive competition by focussing on lowering switching costs in the financial sector.

When consumers can easily switch to new service providers, firms will offer better services at lower prices to win new customers and keep their existing customers. Barriers to entry and expansion will also be lower because new entrants can more easily enter and grow in the market when consumers can switch providers easily and cheaply.

Low switching costs encourages dynamic competition as businesses strive to innovate to keep current customers and attract new ones, who can easily shop around and select the best service provider. Importantly, even the threat of switching enhances competition by putting competitive pressure on incumbents to retain their customers.

Considering these benefits for competition and consumers, policymakers should aim to reduce switching costs. Switching costs are “real or perceived costs of time, effort and money” that consumers incur to switch providers.^{Footnote 33} These costs can lead to consumer inertia where, even when competitive options arise, consumers are unwilling to undertake the seemingly difficult task of comparison shopping and ultimately switching service providers.^{Footnote 34}

As noted in the Bureau’s 2017 fintech market study report, Canada’s financial services industry is characterized by significant barriers to entry and a general lack of customer switching between providers.^{Footnote 35} In markets that are characterized by such “sticky” consumers,^{Footnote 36} incumbents will have less incentive to compete vigorously as consumers are not able to react by effectively switching to other providers with better rates and/or services.

In this context, the Bureau encourages Finance to move forward on implementing a consumer-driven banking framework and urges policymakers to remove barriers to borrowers’ ability to switch to a new mortgage lender when renewing their uninsured mortgages. We discuss both recommendations below.

Recommendation 1: Adopt a consumer-driven banking framework at the earliest possible opportunity

The Bureau welcomes the federal government’s commitment to deliver consumer-driven banking to Canadians by 2025.^{Footnote 37} Consumer-driven banking, also known as open banking or consumer-directed finance, refers to frameworks that provide a secure means through which consumers can transfer their financial data to approved financial service providers of their choice.^{Footnote 38} This is done through an application programming interface (“API”), which is a type of software that enables products and services to communicate with each other.^{Footnote 39}

An effective consumer-driven banking framework will significantly support competition in the financial sector by reducing barriers to entry, promoting consumer switching, and facilitating multi-homing practices (i.e., the use of multiple service providers where possible).^{Footnote 40}

Consumer-directed finance can provide consumers with greater control over their information, and provide a secure means for consumers to access a broader range of innovative products and services.^{Footnote 41} Now, Canada continues to lag behind its international counterparts.^{Footnote 42}

To ensure that Canada’s consumer-driven banking framework effectively delivers the benefits of competition to the financial sector, it is critical for decision-makers to implement pro-competitive policies. For years, the Bureau has advocated^{Footnote 43} for an effective consumer-driven banking framework that can support competition in the financial sector by:

• Reducing switching costs, which would incentivize market participants to compete more vigorously for customers.
• Reducing consumer search costs, which would make it easier for consumers to compare products and allow them to make more informed decisions.
• Reducing barriers to entry, which would facilitate the entry of more competitors (and threat of entry) into the marketplace. This would enhance competitive pressures in the marketplace and facilitate the entry of innovative newcomers, bringing a diverse set of products to the marketplace.

The Bureau is pleased to see many of its recommendations factored into the federal government’s Policy Statement on Consumer-Driven Banking (Policy Statement), which was released in November 2023. The Policy Statement is a welcome development that includes important pro-competitive features such as:

• Having an independently-led body with responsibility for supervising the system, enforcing common rules, accrediting market participants, defining, and updating technical standards. This decision would ensure that accreditation decisions are made by an independently-led body, such that no party with a stake in the commercial outcomes of an accreditation decision can determine accreditation.
• Adopting a single technical standard (i.e., common API standard) with principles and oversight that will be set out in legislation. API standards promote compatibility and interoperability between systems. By moving forward with a common API standard, the government can most directly facilitate entry by non-incumbent, competitive financial service providers.
• Promoting reciprocal access to in-scope data among participants in the framework.

The Bureau encourages Finance to swiftly implement such a framework so that Canadian consumers and businesses can benefit from competition as soon as possible. The following considerations will be important as further details are developed through future legislation and regulations:

• Decision^-makers should ensure that the adoption of a single technical standard is sufficiently flexible to accommodate new and innovative use cases. One risk of having a single technical standard is that it is inherently more difficult to update than (multiple) individual standards. This can reduce the incentives for service providers to introduce new and innovative ways of exchanging data. That is why the adoption of a single technical standard should be done with flexibility as a key objective to enable new and innovative use cases.^{Footnote 44}
• A consumer-driven banking system should include an effective redress model where disputes among industry players can be heard and decided.^{Footnote 45}

Finally, it is encouraging to see the federal government acknowledge the important role that provinces can play to maximize participation in Canada’s consumer-driven banking system. The Bureau supports collaboration among regulators at all levels of government to enable a clear and unified approach to risk, innovation, and competition.^{Footnote 46} Coordination with provincial governments will be key to facilitating a harmonized approach to consumer-driven banking that effectively delivers the benefits of competition to Canadians.^{Footnote 47}

The government’s expressed intention to harmonize its approach with Canada’s key international trading partners is laudable as it will harmonize regulations across geographical boundaries to promote firms’ ability to enter and operate across borders.

Recommendation 2: Enable competition in mortgage-switching without a stress-test at renewal

For many Canadians, home ownership is the biggest financial decision they will make in their life. Most home buyers take out a mortgage to achieve this. Because of the size of most mortgages, being able to benefit from competition and save even a fraction of a percentage point on a mortgage would lead to significant savings.^{Footnote 48}

When consumers renew their mortgages, their ability to switch to a competitive mortgage offer is critical to ensure they obtain the best rate and terms to serve their needs.

Many Canadians are familiar with the requirement to pass a so-called “stress test” to qualify for their mortgage. The stress test is a prescriptive standard set by the Office of Superintendent of Financial Institutions (OSFI)^{Footnote 49} that applies to Federally Regulated Financial Institutions (FRFI).^{Footnote 50} The rule requires these financial institutions to ensure borrowers can still make mortgage payments if they experience financial shocks such as an increase in mortgage interest rates or an increase in household expenses.^{Footnote 51} This is also known as the minimum qualifying rate, and is higher than the actual mortgage rate.^{Footnote 52}

Conducting the stress test when a borrower is looking for a loan to purchase a new house has been a key policy to ensure that borrowers qualify for loans they can afford. Housing commentators note that it has served its purpose as a safety net, which has proved critical at a time when Canadians continue facing higher mortgage interest rates.^{Footnote 53}

Currently, the stress test is not applied evenly across lenders when borrowers renew their uninsured mortgages.^{Footnote 54} If a borrower wants to switch lenders at renewal, OSFI requires the new lender to apply the stress test. However, if the borrower renews with its current lender, then OSFI does not require the incumbent lender to apply the stress test again. According to OSFI, switching creates a new loan which needs to be underwritten by the new lender, while the incumbent lender has already underwritten the loan. This is the case even for so called “straight switches” where there is no increase to the loan amount or amortization.^{Footnote 55}

Last fall, Finance made it clear that Canadians with insured mortgages^{Footnote 56} do not need to pass the stress test again when they renew their mortgages with a different lender.^{Footnote 57} While this is a pro-competitive step, it only helps some homeowners. Most mortgages are not insured. The share of uninsured mortgages from FRFIs has been growing and reached 73% of all mortgages in the second quarter of 2023.^{Footnote 58}

The benefits for borrowers to shop around and switch mortgage lenders is well known. The expectation to conduct the same stress test again at the time of renewing uninsured mortgages risks harming borrowers and the competitive process. This rule makes it difficult if not impossible for some homeowners to find a new lender and take advantage of cheaper interest rates.

When a borrower cannot switch to another lender, the current lender faces almost no competition and can offer higher rates to these captive borrowers without fear of losing their business. This contrasts with borrowers who can shop around or have other options, where lenders are incentivized to offer lower rates or better mortgage products that best fit their needs.

This is not just a theoretical concern. There is empirical evidence that borrowers pay more when remaining with their current lender. A Bank of Canada Staff Working Paper that examined the impact of the stress test found preliminary evidence of so-called “invest-then-harvest” pricing behavior. It particularly notes that “Borrowers who renew their mortgage with their incumbent bank on average pay interest rates 6.1 basis points (bps) higher than new borrowers, and borrowers who switch banks at renewal on average pay 10.2 bps lower than those who stay.”^{Footnote 59}

Despite the potential cost savings available from switching, only 12.1% of mortgage renewers ultimately opt to switch providers.^{Footnote 60} This is in line with low switching rates in the financial sector, more generally.^{Footnote 61}

Considering this, and the fact that the residential mortgage sector already exhibits a high degree of concentration – with the big six bank lenders accounting for about 73% of all outstanding mortgages^{Footnote 62} – policymakers in the financial sector should focus on promoting and facilitating switching rather than discouraging it.

The need to act is pressing in the current context of higher mortgage interest rates in Canada, where an estimated $600 billion worth of mortgages will be renewed in the next two years.^{Footnote 63} According to the Canada Mortgage and Housing Corporation (CMHC), in 2024 and 2025, an estimated 2.2 million mortgages will be facing higher interest rates. This represents 45% of all outstanding mortgages in Canada, including over 1.4 million uninsured mortgages.^{Footnote 64} To ease the burden of their mortgage payments in these circumstances, many are considering switching lenders.^{Footnote 65}

With the current high interest rates, some borrowers may be unable to pass the stress test even though they have good credit and would have been able to service their loan. These borrowers will have to remain with their current mortgage provider, where they will not need to pass the stress test again.^{Footnote 66}

It is important to emphasize that these borrowers present the same risk in either case, they have the same income and are seeking the same mortgage on the same house. In fact, switching, or the credible threat of switching, may actually lower the risk of a borrower’s inability to repay their mortgage to the extent it results in lower interest rates or other more preferential financial terms.

Bank of Canada researchers make a similar point: borrowers unable to switch could face higher mortgage interest rates than if they could switch because of their reduced ability to play different lenders off against each other when negotiating the terms of their mortgage renewal.^{Footnote 67}

To allow more borrowers with uninsured mortgages to benefit from competition among lenders, policymakers should consider not expecting new lenders to apply the stress test to “straight switch”.^{Footnote 68} This change should be limited to borrowers switching from one FRFI to another FRFI.^{Footnote 69}

Such a change need not compromise other financial sector public policy goals. There are other rules in place to protect the safety of FRFIs and ensure they adopt good loan approval practices.^{Footnote 70} An outcome-based approach to risk based on the borrower’s ability to pay their renewed mortgage may vary across lenders, depending on the lender’s risk appetite, portfolio, and market strategy. This may let lenders innovate and compete for borrowers with good credit throughout the life of the mortgage, while still following their own risk assessments. Regulators can also monitor lenders to ensure the financial system remains safe and sound.

In this way, borrowers could benefit from greater competition while the safety and soundness of lenders is maintained.

Conclusion

The financial sector is very important for Canadians and the economy. That is why the Bureau works hard to promote and protect competition in the sector and why we appreciate Finance’s efforts to make the sector more competitive. To that end, we urge financial policymakers to take meaningful action to address how their policies affect competition. Canadians want more competition in the financial sector. The measures we set out in this submission can help them enjoy the benefits of a competitive financial sector.