The government should allow both bank, and bank and insurance company mergers, with the condition that their ATM systems be opened up to new entrants. That’s according to David Bond, former HSBC chief economist.

He also recommends that the government subsidize access to basic banking services to mollify special interests.

Bond, currently adjunct professor of Finance at the University of British Columbia’s Sauder School of Business, makes his arguments in a new background paper for the C.D. Howe Institute released today.

In the paper, he laments that the government has been unwilling to let market forces prevail in the financial sector, bowing instead to special interests. “In the current political situation, it appears that frustration will be the lot of both the consumer seeking better and lower-cost financial services and the bank shareholder seeking an improved return on investment,” he says, warning that “Economically sensible bank mergers will be precluded because they are almost sure to result in costs to some special interest group.”

His solution is to have the government buy basic banking services for special interests, rather than effectively requiring bank shareholders to fund them. “All of those groups that have pushed so ardently for the interests of their members must believe that a redistribution of income from bank shareholders to them is of benefit to the entire nation,” he says. “Why, then, do they see fit to put the bulk of the cost of meeting those demands upon one particular group — bank shareholders — rather than on the widest possible tax base?”

Bond suggests that socially desirable special services could be put out for bid by the government, with the taxpayers funding the cost; or subsidizing particular groups to buy them. “Such a course of action would require strict accountability to the public as a condition of subsidy, and there would be public pressure to forego the provision of a service if costs proved to be unjustifiable,” he says, “An added advantage of having government directly subsidize the desired services is that it obviates the need for the complex set of regulations and new bureaucratic structures that flowed out of the 2001 revision to banking legislation.”

Once the special interests are taken care of, Bond says that mergers could then be allowed between banks and among banks and insurers, with the condition that their ATM networks be made “fully functional” — in other words, ensuring that anyone with a bank card with any bank would be able to use any bank-owned ATM to do whatever they can do with the ATMs of their own institution.

“Full functionality is essential to enable new deposit-taking entrants to collect deposits,” he says. “Government should enable the big banks to rationalize the branch network through mergers, while stifling their power to curb entry of new competitors. Put another way, the 21st-century equivalent of a branch is an ATM, so let us use that technology to push the Canadian banking industry into the world of global competition.”

“Having the government purchase social goods, allowing competition in banking and developing full functionality is a simple and effective solution to the merger issue, and it will ensure that government will not pander to special interests by using bank shareholders’ money; rather, the special interests will have to prove the merit of their case during the annual budget allocations within government,” he concludes.

“At the same time, government will have to allow banks to concentrate on their primary roles of providing a safe place for holding excess funds, for providing payment services and providing finance, rather than working on the government’s social agenda. This rather radical course of action may have limited political payoffs. It would, however, make Canada a more prosperous nation.”